We can simplify our analysis of a leading indicator by simply writing code that tests its efficacy when its applied to the relevant contract. In the case of the Euro fuel gauge we can set the following rules:
- Buy the Euro if the gauge crosses above 65 (it ranges between 0 and 100)
- Short the Euro if the gauge crosses below 35
- Exit the long if it crosses below 50.
- Exit the short if it crosses above 50
There shall be no stops and no profit targets. We would expect there to be some periods where the system (the gauge) fails as a significant factor is driving prices that is not in the gauge and does not affect the components of the gauge.
Over the last ten years we can see our profit curve – trading a 1 lot with no slippage or commissions taken into account:
We can see a hole in performance in the early 2015 period. In the first half of that year interest rates rose and the Euro rallied. Euro yields rose faster than US rates which is extremely rare so the model failed. Other than that period, the simple filter system worked extremely well.
Now let’s get pickier. We shall set the threshold to buy at 75 and to short at 25:
We still get a drawdown in 2015. It is smaller but overall profitability is also lower. These results prove the value of the index as a filter. If you have your own entry and exit criteria then you can integrate the gauge with your work.
On its own, it works just fine.