Trend Without Hiccups - A Kalman Filter Approach
35 Pages Posted: 21 Mar 2016 Last revised: 26 Apr 2016
Date Written: April 12, 2016
Have you ever felt miserable because of a sudden whipsaw in the price that triggered an unfortunate trade? In an attempt to remove this noise, technical analysts have used various types of moving averages (simple, exponential, adaptive one or using Nyquist criterion). These tools may have performed decently but we show in this paper that this can be improved dramatically thanks to the optimal filtering theory of Kalman filters (KF). We explain the basic concepts of KF and its optimum criterion. We provide a pseudo code for this new technical indicator that demystifies its complexity. We show that this new smoothing device can be used to better forecast price moves as lag is reduced. We provide 4 Kalman filter models and their performance on the SP500 mini-future contract. Results are quite illustrative of the efficiency of KF models with better net performance achieved by the KF model combining smoothing and extremum position.
Keywords: Kalman filter, systematic trading, moving average crossover, filtering, managed futures, CTA
JEL Classification: G02, G1, G13, G14
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