Dickey Fuller Test

Dickey Fuller Test: trading basics

The Dickey Fuller test is used in trading to assess whether a time series is stationary. Stationarity is significant in trading since it means the mean, variance, and autocorrelation of time series stay constant. However, non-stationary time series might show trends, cycles, or other regular patterns that make future values difficult to forecast.

Why Stationarity Matters?

Stationarity is key in trading since most techniques assume previous trends will reoccur. Predicting and trading a non-stationary time series is difficult. By using the Dickey Fuller test, traders may decide whether a time series fits their plans.

The Dickey Fuller Test

The Dickey Fuller test uses the autoregressive integrated moving average (ARIMA) model, a popular time series analysis technique. The test estimates and compares two hypotheses:

Null Hypothesis: Non-stationary time series.
Alternative hypothesis: Time series stationary.

against reject the null hypothesis, the test statistic is compared against crucial values. If the test statistic is below the crucial value, the null hypothesis is rejected, suggesting stagnant time series. However, if the test statistic exceeds the crucial value, the null hypothesis is not rejected, indicating non-stationary time series.

Results Interpretation

The Dickey Fuller test yields a statistic with crucial values. The test statistic is compared to crucial levels to assess time series stationarity. When the test statistic is below the critical levels, the time series is stationary. If the test statistic exceeds the critical values, the time series is non-stationary.

The Dickey Fuller test may help traders choose trading tactics. Because stationary time series are more predictable, traders may use classic trading tactics. Analysis or different trading tactics may be needed for non-stationary time series.

Conclusion

Traders may use the Dickey Fuller test to assess time series stationarity. By testing a time series, traders may determine its predictability and applicability for their trading strategy. Understanding stationarity and employing tests like the Dickey Fuller test helps enhance trading choices and market performance.

References and sources:

– https://en.wikipedia.org/wiki/Dickey%E2%80%93Fuller_test
– https://www.investopedia.com/terms/d/dickey-fuller-test.asp
– https://www.statisticshowto.com/dickey-fuller-test/