Performance of the average directional index as a market timing tool for the most actively traded USD based currency pairs

Abstract

The aim of this study is to test a trading system based on the average directional index, which is complemented with the parabolic stop and reverse indicator. The trend-based system is tested onto the most actively traded USD based foreign currency pairs, using both monthly and weekly data set over 2000-2018. Sharpe and Sortino measures are used to track the performance of the currency pairs, based on total risk and downside risk assumptions. Results are robust tested by decomposing the data into pre and post 2008 financial crisis. Using an investment horizon over 18 years, the reliance upon the monthly model produced lower maximum drawdowns and lesser trades than the weekly model. While Swiss Franc had the best (worse) performance in the monthly (weekly) based model, the Chinese Renminbi witnessed the worse (best) performance in the monthly (weekly) based model. Pre and post financial crisis decompositions suggest the weekly-based system is more reliable than the monthly one with relatively more trades and positive performance, where the Chinese Renminbi and Japanese Yen posted the highest Sharpe and Sortino values of 0.996 and 4.452 respectively in the post crisis period. Proportionately high level of negative returns coupled with relatively low positive Sharpe and Sortino values, however, suggest that a trading system relying on the average directional index and parabolic stop and reverse indicator to be further tested and analyzed at higher frequencies. © 2018 Nelli Heorhiadi, Oleksiy Druhov, Roksolana Vilhutska, Mariana Bets, Andrii Stoianovskyi, Mateusz Folwarski.