An experiential learning module has been introduced to the University of Dayton Business School for the fall 2009 term: Managing a small currency portfolio around market trends. This new module dovetails with the Davis Center for Portfolio Management, which focuses on the management of a stock portfolio, and will be managed out of the Hanley Group Derivatives Trading Center. The module will be managed along the lines of “Adding Girth To Your Profits” (Futures, December 2008). The girth model is a trend-following model incorporating volatility, momentum and velocity.
There are significant operational risks to managing a forex portfolio in an educational setting, even using a non-discretionary model. Foremost, the students are novices to the commodity markets, the method of the model management itself, and the trading software used. Therefore, the first semester is an implementation of the model using a simulation platform, and focuses on the methodologies of the markets and the nuances of the model.
Only if the students demonstrate the discipline and the desire to continue on a team-based approach to managing a forex portfolio will real money be used. However, the simulation will look and feel like a real portfolio; thus, any significant operational risks will be brought to light without the danger of a large monetary loss.
THE TRADING METHOD
Students at the University of Dayton will manage a euro portfolio around the four-hour currency cycle. They will use the 10-period exponential moving average (EMA) and the 20-period EMA as their proxy for market trend. The model will enter new trades only on an EMA cross (for example, if the 10-period EMA crosses above the 20-period EMA, the model will go long).
We will calculate girth at the close of each four-hour candlestick. We will use girth as an early close indication to both long and short positions. Existing trades will be closed when the girth indicator decreases below a specified threshold, indicating that the trend may reverse.
Reviewing “Early out” shows how the model picked a strong trend upward, and indicated an early close to the upside trade in late May. However, the students would still be watching the girth number at the four-hour intervals. We saw a limited cross to the downside and then a resumption of the uptrend. The students would be watching the four-hour girth threshold and the trend indicators and would have entered another long position.
The graph shows how the trends and the girth indicator are used to preserve profits pending a reversal in trend. During the late May move from 1.34 to 1.44, two long positions were taken. They were both entered at the time of the EMA cross. Both trades were exited prior to the EMA cross, when the girth figure crossed below the girth threshold. Typically, early exit due to decreasing girth results in a more favorable profit position than that taken if the trader simply waited for an exit on the EMA cross to the downside.
On or around the second week of classes, following training in market methodology and the use of a disciplined trading plan, the students will open one simulation account for the management of the girth model. Working with novice traders has necessitated having, at most, one open position at a time in the portfolio.
The girth model presented in the December 2008 article also has been simplified to its base form: using girth only to indicate early exit, not using girth to add positions in a strong up or downtrend. Teaching novice traders a strict control on data input, trade entry, trade exit and passing the book to the next group watching the next four-hour time block will be difficult enough. In other words, the operational risk of managing the simplified early exit position is great. Additionally, we do expect human error.