ABN AMRO pioneers FX model that predicts price behaviour in EUR-USD spot rate
ABN AMRO today launched a groundbreaking foreign exchange model that
indicates whether the EUR-USD exchange rate is likely to trend higher or
lower, or instead be subject to movements within a trading range.
The ABN AMRO FX Regime Prediction Indicator,the first proven model of
its kind, assesses market volatility and positioning to assign a
probability factor to likely movements in the EUR-USD spot rate in the
“This tool provides currency traders and portfolio managers with an
extra level of sophistication and choice in managing their currency
exposure,” said Aziz McMahon, Senior FX Strategist at ABN AMRO.
Typically, currency managers use one of two strategies: ‘trend
following’, which takes positions on long-term trends; and ‘volatility
capture’, which uses option positions to sell volatility between trends.
Adopting a single strategy can cause losses: a market that is range
trading undermines maintained long or short positions, while short
volatility positions fail to take advantage of trending movements in the
This risk has been traditionally hedged by currency managers adopting
both strategies side-by-side. There is a limit to the potential losses
of a single strategy, but also potential profits are lower.
By following the ABN AMRO FX Regime Prediction Indicator,currency
managers can now confidently employ a switching strategy, using ‘trend
following’ when the probability is high that EUR-USD is trending up or
down, and ‘volatility capture’ when the probability is high that the
EUR-USD exchange rate is simply range trading.
The model has been built from data over the January 2000 to December
2002 period and tested for the period between January 2003 to the end of
March 2005. Table 1 overleaf illustrates the superior returns of
adopting a strategy of switching between trading styles, following the
Regime Prediction Indicator, as compared to a simple strategy of
following trend or range trading styles.
In addition, the table illustrates the returns from allocating capital
to each trading style according to a probability estimate of whether the
trading regime is in ‘trending’ or ‘ranging’ mode. This latter
probability signal produces lower returns, but has the benefit of less
volatile returns than the pure switching indicator and also a higher hit
ratio. The two signals may not always coincide, but together they give a
better guide to market conditions.
Table 1: Trading rule comparisons: Regime switching increases returns
and information ratio * in our out of sample test. Returns based on
period Jan 2003 – March 2005.
Annualized Information Annualized Biggest 1- Hit Ratio (%
Trading mean weekly Ratio standard week loss winning
Rule return deviation of trades)
Trend 3.80% 0.39 9.63% -3.85% 60.3%
Volatility -2.16% -0.38 5.70% -2.78% 51.7%
Static 50: 0.57% 0.09 6.17% -3.31% 69.8%
Switching 8.41% 1.08 7.77% -3.85% 61.2%
Probability 4.13% 0.74 5.59% -2.94% 68.1%
Source: ABN AMRO
*The ratio of return in relation to risk - the higher the ratio, the
greater the return relative to risk
“Our tests show that using our indicators to dynamically switch between,
or to adjust the weightings of, different trading styles produces
significant improvement on returns compared to a passive approach,”
“The latest model output is a weak signal in favour of EUR-USD trending.
The signal is so weak that it is not endorsed by the probability-
weighted indicator. This latter indicator is modestly favouring a
“Regime changes have been more frequent than normal in 2005, indicating
a very uncertain market. For the coming week our system would recommend
investors hold modest short EUR-USD positions,” McMahon added.
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Mark Bennewith +44 20 7678 8270
Notes to Editors:
Netherlands-based ABN AMRO is a leading international bank with total
assets of EUR 608.6 bln (as at 31 December 2004). It has over 3,000
branches in more than 60 countries and territories, and has a staff of
about 100,000 full-time equivalents worldwide. ABN AMRO is listed on the
Euronext and New York stock exchanges.
ABN AMRO operates through three Strategic Business Units, each
responsible for managing a distinct client segment. Wholesale Clients
provides integrated corporate and investment banking services to
corporate, institutional and public sector clients worldwide. Consumer &
Commercial Clients focuses on retail and SME clients in three home
markets – the Netherlands, the US Midwest and Brazil and in a number of
selected growth markets. Private Clients & Asset Management provides
private banking services to wealthy clients and investment products to
financial intermediaries and institutional clients.