Wednesday, 12 November 2014

First Use for the MFE/MAE Indicator

This first use is as an input to my Cauchy-Schwarz matching algorithm, previous posts about which can be read herehere and here. The screen shot below shows what I would characterise as a "good" set of matches: 
The top left pane shows the original section of the price series to be matched, and the panes labelled #1, #5, etc. are the best match, 5th best match and so on respectively. The last 3 rightmost bars in each pane are "future" price bars, i.e. the 4th bar in from the right is the target bar that is being matched, matched over all the bars to the left or in the past of this target bar.

I consider the above to be a set of "good" matches because, for the #1 through #25 matches for "future" bars:
  • if one considers the logic of the mfe/mae indicator each pane gives indicator readings of "long," which all agree with the original "future" bars
  • similarly the mae (maximum adverse excursion) occurs on the day immediately following the matched day
  • the mfe (maximum favourable excursion) occurs on the 3rd "future" bar, with the slight exception of pane #10
  • the marked to market returns of an entry at the open of the 1st "future" bar to the close of the 3rd "future" bar all show a profit, as does the original pane
However, it can be seen that the above noted "goodness" breaks down for panes #25 and #30, which leads me to postulate that there is an upper bound on the number of matches for which there is predictive ability for "future" returns.

In the above linked posts the test statistic used to judge the predictive efficacy of the matching algorithm was effect size. However, I think a more pertinent test statistic to use would be the average bar return over the bars immediately following a matched bar, and a discussion of this will be the subject of my next post.  

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