TheEconomist's Forex Arbitrage Blog

I don't know where you come up with those ideas but I like every one of your posts, I have to admit that I need time to digest the information since I like to apply the idea on a real example, but your posts are very smart and informative

I don't know where you come up with those ideas but I like every one of your posts, I have to admit that I need time to digest the information since I like to apply the idea on a real example, but your posts are very smart and informative

 

Thanks for the appreciation, I'm trying to do my best and keep thinking outside the box...

 

Regards,

Bogdan

Hi Bog.

 

Very nice idea and a bit unusual, as I like it.

With the right broker and a good automation this should be possible.

 

Have to think a bit about it. Please keep in touch with this idea (but don't forget the bonds *g*).

 

Best wishes, Andi.

Nice. Long time I did not laugh so loud.... I like it... Especially the part with "We continue to "refresh" the moving average, replacing the oldest buy with a new entry on every bar". I.e, close a buy that you had before, just to open a new buy with the same qty, and pay again the spread.... What for? It is not better to keep the old buy? and save the spread?

 

At the end, you will make a profit of (price-MA)*lots, but you just lost N*(price-MA)*(lots/N) when you closed you sell trades on "launch" step. You closed them just to open a new sell with an amount of their sum. What for? just to pay the spread?

 

Finally, after closing everything, you will have a profit of a big ZERO, and you paid spread three times, worse then for futile hedging, where you pay just double spread, for the same 0 profit. The rest, no difference. You paid 2/3*N*(S/N)+S/3 spread. That is all.

 

I did not laugh because of the article, as you can see, the author says this is a "fallacy". I just laugh that after all, some people are still ready to jump in...

 

Good luck then...

I think the fallacy is that you don?t know where the MA will go .. up or down. Why do I point out this. Well, when you construct the position MA (10) (for example 10 period MA) you either have to be long or short the MA..so do I enter long or short trades? If you go long MA and prices go down you will loose with MA...

Also, buying and selling at the same price you are doing nothing..only wasting pips.

Bog thanks for you thinking but it does not work.. Am i missing something?

Well guys, you are right. I found the fallacy. Pretty tricky.

 

 

Say a moving average of 4 values is comprised of:

 

( 1.4501 + 1.4502 + 1.4503 + 1.4504 )/4 = 1.45025

 

If it comes a next value, say 1.4510 , it changes:

 

( 1.4502 + 1.4503 + 1.4504 + 1.4510 )/4 = 1.450475

 

a growth of 6 pips of last quote produces 2.25 pips in MA gain.

 

Supposing I had trades open on the first quotes. Then results are (supposing no spreads)

 

The first trade of 1.4501 closes at 1.4510 with a profit of 9 pips ; on a quarter of volume, 9/4 = 2.25 = 1.450475 - 1.45025 ; the other open trades have an unrealized value of (8+7+6)/3*(3/4) = 5.25 pips.

 

The trades emulated the MA; however, on the other side, there are the sells, opened at Bid prices, always higher, putting the hedge on loss.

I thought that "refreshing" the MA would keep it going like it should, as I knew that once the MA stops , the hedge would be futile.

 

But it is futile from beginning, due to the opposite MA hedge.

 

Average is right. There is no arb potential. There will not be a BOTH SIDES PROFIT if the market heads towards the MA, like in oil arb crossover, for example. They will absorb each other and produce losses with spreads. This is the real trick: to have a hedge like it was put some time before, but without endangering the portfolio, neither being futile.

 

Later edit: this sci-fi hedge would create a profit at the very time we were thinking to trade. Crossover won't be needed, just a close is enough to get profits.

 

 

Perhaps this is the TRUE FALLACY : USING ONE ASSET. We should stick to arb on every step we make.

Well guys, you are right. I found the fallacy. Pretty tricky.

 

Later edit: this sci-fi hedge would create a profit at the very time we were thinking to trade. Crossover won't be needed, just a close is enough to get profits.

 

Would you explain this.

 

Andi

Well guys, you are right. I found the fallacy. Pretty tricky.

 

Later edit: this sci-fi hedge would create a profit at the very time we were thinking to trade. Crossover won't be needed, just a close is enough to get profits.

 

Would you explain this.

 

Andi

 

It's because of the fact that the market and the MA are two faces of the same coin. When you sell Crude light at 90.50 and you buy West Texas Intermediate at 89.95 you know the arb exists. It's embedded in the value of the portfolio. When the Crude light goes down and WTI goes up, both trades are winning. In our case, when the market goes down it also generates the MA loss, because it is made of dozens of market reverses (buys).

I entitled the hedge as sci-fi because it required two impossible conditions:

1. no other branch (no sell branch, for our example, otherwise this would cancel the internal "value" made up by the MA), in which case you would have been unhedged all the way.

2. no futile hedge, meaning that, even with a sell branch - insuring hedge all the time - the result shouldn't have been futile (which is impossible).

 

Practically, sci-fi means that at the moment you were wanting to "sell" the market to realize the profit was already there, realizable just by closing the Buys MA at the "market" price, which is impossible, all profit being consumed by the Sells MA. This is the thing I didn't realize from the beginning. I thought that once you close the Sells MA you are left with a Buy MA that will increase in value as the price is decreasing (because price comes from the market, not from the MA), even more, while "adjusting" the MA with new trades. To make a comparison with the oil arb, it's just like you'd expect the WTI to go up and meet CL, while the WTI would be only a humbug in your mind, its real datafeed being CL, therefore taking the rope as a snake.

 

Perhaps I mixed up this a little, it's a bit phylosophical, like half of the Finance. If an entire model is based on an unrealistic valuation, it all goes down the drain.

Bogdan

I think the fallacy is that you don?t know where the MA will go .. up or down.

 

It does not really matter where the MA goes. The fallacy has two reasons. First reason comes from the fact that you can not do arbitrage with only one instrument, as Bogdan said before: if you want to arbitrate (i.e. being referee, in Romanian language we use the same word), then you need two teams, as in soccer. The example with the oil is very good. You can not do arbitrage on just a single forex pair, this will lead you to nowhere.

 

The second reason of the fallacy relies in the method itself. Supposing that you choose a N period for your MA, and you trade a volume of N lots for the price, then in the first step you have to open N trades long and N trades short to construct the MA. Does not matter which prices you opened the trades, does not matter where the MA goes, you are hedged, and paid 2 times the spread. Then later on, after you construct the MA, you have to play the second step: opening ONE trade on the market price, with N lots. It does not matter the direction, again. Let's say for the sake of the example that you decide for short. According with the method, you will close all N short orders already active, to open a new short with N lots. What the fun is going on? You just paid one more spread for all lots, and YOU ARE STILL HEDGED. Does not matter where the price or the MA goes, does not matter how long you keep the bets, but when you close them your profit will be zero. And you just paid 3 times the spread. I mean 3*(N*Lots*Spread) in fact...

 

If you add the "refresh" steps, i.e. paying a (1*Lots*Spread) every time when you "refresh" the MA, then YOU ARE STILL HEDGED, but payed more spread. Still no profit, still no potential profit.

 

This MA-trick could be very interesting stuff if we find something ELSE to hedge it with. I mean not to hedge it with itself, but to find a different instrument, like oil, gold, another currency pair, etc. But just now I have no idea how this could be done...

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