Forex: Digging Into the DV1 Period Indicator

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Includes: EU, FXF, UDN, UUP
by: ETF Prophet

For a while I’ve puzzling over forex markets and how they differ from other markets such as US equities. After much research, I can certainly say (surprise, surprise) that FX is a very different market and compared to the SPY, a lot harder to trade with some consistency.

Why bother? Partly personal trading (small portion of my activities), partly for a publication I edit, but primarily because it bugs me that I am yet to find an approach offering the sort of consistency I can find on other markets. I’m talking low leverage position trades based around spot markets. I thoroughly agree with and have blogged about the forex hustle that rigs the market against over leveraged and underfunded day traded retail forex accounts.

The Average DVB is something I have employed since researching it here to good effect [The Average DVB buy signal has been useful for trading around since the middle of January], but I still feel there is more to be uncovered.

The popular DVB indicator from David Varadi and other such indicators have been employed to great effect on the SPY and other US markets, but they mostly do not work on forex markets, at least to the same potency. There are many factors possibly explaining this such as the 24 hour nature of FX markets and the lack of an inherent market directional bias.

After a tip from David Varadi, I decided to have a look at the performance of DV1 period indicator. This is the same calculation as the DV2 (DVB), but with the first part of the calculation applied to 1 day only.

Specifically I looked at extreme positions for mean reversion – i.e. buy into extreme weakness and sell into extreme strength.

The conditions were as follows:

Buy: DV1 <0.25. Close Buy DV1 >0.75
Sell: DV1 >0.75. Close Sell DV1 <0.25

Results were mixed, but this wasn’t too unexpected, given DV’s hints about the importance of volatility ranges to compliment a basic method.

However, the results from two currency pairs provided some interesting results:

EUR/ USD

No commission to interest rate differentials taken into account. It remains to be seen how much the latter would impact on results in reality in particular. Results back to 2000.

11-04-2011 21-29-09

Things were looking very consistent until around 2004 when things went flat, then negative, then collapsing from 2008 with the credit crunch.

The performance of the EUR/ USD contrasts remarkably with that of the USD/ CHF (USD to Swiss Franc).

11-04-2011 20-49-47

Here we can see the method performing with a high degree of consistency even through the credit crunch and sovereign debt crisis.

Is there anything special about the Swissy? In some ways yes, with the Swissy seen as a safe haven, but this would miss the point… What are the characteristics that differentiate the EUR/ USD from the USD/ CHF?

Volatility? Trendiness? Range violations? All of these?

I hope to find out.