Analysis of Ornstein-Uhlenbeck process stopped at maximum drawdown and application to trading strategies with trailing stops

TL;DR

This paper introduces a trading strategy based on Ornstein-Uhlenbeck processes, providing theoretical analysis and hypothetical results for currency trading with trailing stops, emphasizing mean reversion properties.

Contribution

It offers a novel approach by modeling currency rates with Ornstein-Uhlenbeck processes and deriving explicit formulas for maximum drawdown, supporting automated trading strategies.

Findings

Theoretical justification of strategy profitability

Explicit formulas for Ornstein-Uhlenbeck process maxima

Hypothetical trading results on currency pairs

Abstract

We propose a strategy for automated trading, outline theoretical justification of the profitability of this strategy and overview the hypothetical results in application to currency pairs trading. The proposed methodology relies on the assumption that processes reflecting the dynamics of currency exchange rates are in a certain sense similar to the class of Ornstein-Uhlenbeck processes and exhibits the mean reverting property. In order to describe the quantitative characteristics of the projected return of the strategy, we derive the explicit expression for the running maximum of the Ornstein-Uhlenbeck process stopped at maximum drawdown and look at the correspondence between derived characteristics and the observed ones.