This article highlights how autocorrelation and linearity for end-of-day prices can benefit your trading strategy. We’ll focus on trading and investing in the Euro ETF (symbol: FXE) with a discount trading indicator. Finally, we’ll work our way to backtest the results of the discounting strategy.
The following is a scatterplot depicting the relationship between the previous day’s Net-Asset-Value (NAV) prices for daily median prices for FXE.
You’ll notice there is a good linear relationship, giving a leg up for those who know how to harness the strength in NAV price information for the Euro ETF (FXE).
The following chart corresponds to the same time horizon as the scatterplot, with daily close prices of FXE:
Notice, there isn’t a strong indication of a trend for the entire period since 2006. This is another reason why the sentiment discount trading strategy works so well. Generally, there shouldn’t be any strong trend on the underlying instrument—up or down—for the strategy to work well.
Since we’ve asserted linearity and autocorrelation in daily median prices, a discounting strategy is a reasonable one for us to expect to be profitable. The main goal of thi…