Part 1 discussed VantagePoint's Predicted Neural Index (PIndex) and presented results of a backtest using it as the only signal to enter trades. PIndex is a proprietary indicator included in VantagePoint Intermarket Analysis Software that predicts whether or not a three-day simple moving average (3SMA) of the typical price (average of the day's high, low and closing prices) will be higher or lower two trading days in the future compared to today.

When the predicted 3SMA value is greater than today's actual 3SMA value, the PIndex displayed by the software is "1.00," indicating the market is expected to move higher over the next two days. When the predicted 3SMA value is less than today's actual 3SMA value, the PIndex displayed by the software is "0.00," indicating the market is expected to move lower over the next two days. So, in our backtest, when PIndex changed value from "1.00" to "0.00" we entered a short trade; when PIndex changed value from "0.00" to "1.00" we entered a long trade.

In the backtest of the USD/JPY currency pair presented in Part 1, 17 trades were entered, of which 14 were profitable, and 12 of the 14 winners reached a 100-pip profit target. The exit criteria were: (1) 100 pips profit or (2) first daily profitable close or (3) being stopped out, whichever occurred first. Stop losses were placed 20 pips above/below the high/low of the entry signal day, depending on the direction of the trade signaled (i.e., long or short).

In real-world trading, entries at the closing price printed on the entry signal day can usually be achieved by entering the market near 0000 GMT, and/or using limit orders to wait for retracements, if necessary. Often, it is quite possible to enter the market at prices better than the closing price printed on the entry signal day.

One additional rule employed in the backtesting was that no "interim trades" were entered, meaning once a trade was entered, no new trades were initiated, regardless of changes in PIndex that might occur, until the current trade achieved one of the three exit criteria described above. This situation never occurred in the backtesting presented in Part 1 but did occur later. This "rule" is not without logic, as it is quite possible the initial PIndex signal indicates the major movement predicted in the market, and any interim PIndex signals that occur prior to one of the exit criteria being reached are minor blips along the route of the major movement.

Updated Backtest Results: Wins Continue

As shown in the figure below, the winning performance of trading the USD/JPY pair using PIndex as an entry signal continued over the past month. Starting Part 2 of the backtesting after the trade entered and closed in Part 1 on March 16, 2009, six new trades were signaled, and all were profitable. Five of the six trades reached the 100-pip profit target, while the sixth achieved 54 pips. This brings the total performance statistics thus far for the year 2009 to 23 trades signaled, with 20 winning trades, for a win rate of more than 86%. Additionally, 17 of the 20 winners reached the 100-pip profit target.

These backtest results are extremely encouraging (who wouldn't like an 80+% win rate?) and indicate the profit potential of trading USD/JPY with the described PIndex approach. However, there are still additional questions that arise:

• Can some losses be avoided? Can we detect times when a PIndex signal should not be acted upon?
• If we opt to stay in a trade longer than the originally planned closing points, or if we stay in a trade waiting to reach a target, when should we decide to exit?
• When might it be safe to re-enter a trend if we seem to have exited or been stopped out prematurely?

Fortunately, VantagePoint provides many additional predictive indicators that can help answer these questions.

Additional Insights from Additional Indicators

In addition to PIndex, the predictive indicators available in VantagePoint can be grouped into five categories:

• Moving averages (MAs) - actual and predicted MAs, & MA crossovers
• Predicted trend differences - predicted differences in short-, medium- and long-term trends
• Predicted strength - predicted difference in the 3SMA used to determine PIndex
• Predicted "classic" oscillators - MACD, RSI, etc.
• Predicted price action - predicted next day high price and predicted next day low price

In reality, each market trades somewhat differently than others, and it is only through observation and backtesting that one can determine which of the additional indicators may be reliable filters for the PIndex signals in the market of interest and which can provide insights into trend strength, trend weakening, etc.

Because VantagePoint utilizes multiple parallel independent neural networks to calculate the various indicator values, we can effectively increase our confidence in trade decisions when we see correspondence and confirmation in multiple predictive VantagePoint indicators. Of course, some or all of them may at times still get it "wrong," especially since real-world events can wreak havoc on even the most established of trends. But at least we are attempting to use VantagePoint's parallel and independent calculations to our advantage. Additionally, when we see disagreement between indicators that we know are relevant to a market of interest, it can give us cause to consider exiting or standing aside and waiting for clearer opportunities.

Additional Indicators for USD/JPY

To address the trading questions listed earlier, I want to focus on three indicators for USD/JPY:

• Predicted short-term trend difference (PTSDiff).
• Predicted strength (PStr).
• Predicted price action (PHigh and PLow).

This article will briefly introduce and describe each indicator. Then in Part 3 of this series, I will describe some ground rules for using them, separately and collaboratively, to gain additional insights to inform our trading decisions, going through several examples to illustrate their use.

Predicted Strength (PStr)

As discussed earlier in this article, PIndex is simply a 'binary' (i.e., "0" or "1") representation of the predicted difference expected in the 3SMA, comparing the MA's current value to its predicted value 2 days in the future. When this difference is positive, PIndex is "1.00"; when this difference is negative, PIndex is "0.00".

PStr is the numerical value of the difference between the current 3SMA and the 3SMA predicted 2 days in the future. Therefore, when PStr is a positive number, PIndex will be 1.00, and when PStr is a negative number, PIndex will be 0.00. When PStr moves from being a negative value one day to being a positive value the next day, PIndex will change from 0.00 to 1.00 and vice versa when PStr moves from a positive value one day to a negative value the next.

By observing the day-by-day changes in PStr, we can understand the strength of the PIndex that VantagePoint is displaying and gain valuable insight. If PStr is increasing strongly in the direction of our trade, that indicates VantagePoint is forecasting a widening difference between the SMAs. This is a good sign of possible continuation. If PStr is moving opposite the direction of our trade, or there is divergence between PStr and the price action, VantagePoint is predicting the SMAs will be getting closer together, and that is a sign of possible trend weakening and reversal. If PStr is approaching its recent historical low or high values, that is also strong indication of future weakness and possible reversal.

Predicted Short-Term Difference (PTSDiff)

PTSDiff is the numerical difference between the moving averages used in VantagePoint's short-term crossover display - namely, the actual 5SMA and the 2EMA (2-day exponential moving average), predicted 1 day in advance (P2EMA+1). Similar to PStr, if PTSDiff is increasing in the direction of our trade, that is an indication of health and continuation. Conversely, if PTSDiff is moving opposite the direction of our trade and/or there is divergence between the market's price action and the movement in PTSDiff, these are indications of weakening and/or impending reversal. Historical high and low values of PTSDiff also serve almost like support and resistance levels, where price action may stall or reverse.

Predicted Price Action (PHigh and PLow)

In calculating the PStr and PTSDiff values described above (and by extension, the PIndex as well), VantagePoint is actually using two different neural networks, one to predict the 3SMA two days in advance and one to predict the 2EMA one day in advance. Because VantagePoint uses separate independent neural networks to predict the next day high and low prices, observing changes in these values in conjunction with the individual and relative movements of PStr and PTSDiff means we will essentially be comparing the predictive opinions of four separate neural networks. If we see correspondence or disagreement among these, we gain valuable insight.

PHigh is the predicted high price for the next trading day, and PLow is the predicted low price for the next trading day. In a trending market, we should see PHigh and PLow essentially moving parallel to each other. If PStr and PTSDiff are indicating strength in the long direction, we would look to see confirmation from PHigh and PLow, which should show predicted increases as well (and decreases if the other indicators are showing strength in the short direction).

Part 3 of this series will review some examples of using these indicators to inform and enhance trading decisions. The indicators we have been discussing are displayed in the figure below, and this is an opportunity for you to observe and consider their behavior, both individually and comparatively. PStr and PIndex are displayed in maroon, and PTSDiff is displayed in orange.

Until next time, good trading!