Currency Trading

Currency trading (forex or FX) offers investors a way to trade on country or regional fiscal/monetary situations and tendencies. Are there reliable ways to exploit this market? Does it represent a distinct asset class?

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Adaptive Higher Even Moment Currency Trading Strategy

Are higher even moments of asset return distributions useful predictors of future returns? In the September 2015 version of her paper entitled “A Low-Risk Strategy based on Higher Moments in Currency Markets”, Claudia Zunft explores an adaptive currency trading strategy that exploits the predictive power of higher even moments of forward currency exchange rate returns. The strategy is each month long (short) the equally weighted fifth, or quintile, of currencies with the lowest (highest) higher even return moments relative to recent past levels. For each currency, she first computes 13 even daily return moments over the last month (versus the U.S. dollar) ranging from 4 to 100 and then subtracts from these moments their respective average monthly values over lookback intervals of 12, 24, 36, 48 and 60 months and inception-to-date. From the resulting 78 combinations of moments and lookback intervals, she each month selects the combination with the highest average excess portfolio return over the last three months. For comparison, she also tests long-short quintile carry trade (high interest rate currencies minus low interest rate currencies) and momentum (high prior-month return currencies minus low prior month currencies) portfolios. Using bid, ask and mid-quote spot and forward contract (maturities up to a year) exchange rates versus the U.S. dollar for 20 of the most liquid developed and emerging market currencies as reliably available during December 1989 through October 2014, she finds that: Keep Reading

Carry Trade Excluding Unfavorable Conditions

Is there an easy way to avoid unfavorable positions within a currency carry trade strategy (long currencies with high interest rates and short those with low)? In their July 2015 paper entitled “Conditioning Carry Trades: Less Risk, More Return!”, Arjen Mulder and Ben Tims examine a carry trade strategy that avoids currencies for which exchange rate return is likely to offset interest rate return (the carry trade is unlikely to work). Based on prior research, they hypothesize that carry-trade-won’t-work conditions are: (1) very high absolute interest rate differences; plus, (2) high exchange rate volatility. They specify an interest rate difference as extreme if it is among the 10% highest monthly absolute differences across all currencies relative to the U.S. dollar over the last 60 months. They specify exchange rate volatility as extreme if the five-year exponential moving average of squared differences between conventional carry trade returns and the average carry trade return over the last 60 months is among the top 25% of values. Using monthly spot exchange rates versus the U.S. dollar and interest rates for 25 currencies as available during January 1975 through May 2015 (with the first ten years used to define interest rate difference and exchange rate volatility conditions as of January 1985), they find that: Keep Reading

Currency Carry and Trend Following Combo

Are currency carry and momentum strategies complementary? If so, why? In their July 2015 paper entitled “Carry and Trend Following Returns in the Foreign Exchange Market”, Andrew Clare, James Seaton, Peter Smith and Steve Thomas examine how market liquidity affects returns to currency carry and trend following strategies and test the benefits of combining these two strategies. They measure carry strategy returns via a portfolio that is each month long (short) the equally weighted currencies with the largest (smallest) returns as implied by differences between one-month forward and spot rates. They measure trend following strategy returns via a portfolio that is each month long (short) the equally weighted currencies with last-month returns above (below) respective moving average returns over the past four to 12 months. Using end-of-month spot and one-month forward exchange rates for 39 currencies versus the U.S. dollar as available during January 1981 through December 2012, they find that: Keep Reading

Good Currency, Bad Currency?

Can currency carry traders improve performance by excluding “bad” currencies? In the April 2015 version of their paper entitled “Good Carry, Bad Carry”, Geert Bekaert and George Panayotov investigate the differences between good and bad carry trades (long high-yield and short low-yield) constructed from G-10 currencies. They define good (bad) trades as those with relatively high (low) Sharpe ratios and slightly negative or positive (more negative) skewness. Their benchmark portfolio is long (short) the equally weighted five G-10 currencies with the highest (lowest) yields. Their process for dynamically and progressively enhancing the currency carry trade universe is to isolate currencies associated with bad carry trades by each month: (1) experimentally excluding currencies one at a time from the benchmark and dropping the one that most depresses inception-to-date Sharpe ratio (inception December 1984); and, (2) repeating until they have eliminated seven currencies. The number of long positions is equal to the number of short positions in all test portfolios, with positions equally weighted. Monthly performance calculations are net (exploiting availability of bid and ask quotes). Using one-month forward quotes on the last trading day of each month and spot quotes on the last day of the next month for all G-10 currencies during December 1984 through June 2014 (354 months), they find that: Keep Reading

Dollar-Euro Exchange Rate, U.S. Stocks and Gold

Do changes in the dollar-euro exchange rate reliably interact with the U.S. stock market and gold? For example, do declines in the dollar relative to the euro indicate increases in the dollar value of hard assets? Are the interactions coincident or exploitably predictive? To investigate, we relate changes in the dollar-euro exchange rate to returns for U.S. stock indexes and spot gold. Using end-of-month and end-of-week values of the dollar-euro exchange rate, levels of the S&P 500 Index and Russell 2000 Index and spot prices for gold during January 1999 (limited by the exchange rate series) through February 2015, we find that: Keep Reading

Year-end Global Growth and Future Asset Class Returns

Does fourth quarter global economic data set the stage for asset class returns the next year? In their February 2015 paper entitled “The End-of-the-year Effect: Global Economic Growth and Expected Returns Around the World”, Stig Møller and Jesper Rangvid examine relationships between level of global economic growth and future asset class returns, focusing on growth at the end of the year. Their principle measure of global economic growth is the equally weighted average of quarterly OECD industrial production growth in 12 developed countries. They perform in-sample tests 30 countries and out-of-sample tests for these same 12 countries (for which more data are available). Out-of-sample tests: (1) generate initial parameters from 1970 through 1989 data for testing during 1990 through 2013 period; and, (2) insert a three-month delay between economic growth data and subsequent return calculations to account for publication lag. Using global industrial production growth as specified, annual total returns for 30 country, two regional and world stock indexes, currency spot and one-year forward exchange rates relative to the U.S. dollar, spot prices on 19 commodities, total annual returns for a global government bond index and a U.S. corporate bond index, and country inflation rates as available during 1970 through 2013, they find that: Keep Reading

Best Currency Value Strategy?

Which method of relative currency valuation works best for currency trading? In their February 2015 paper entitled “Currency Value Strategies”, Ahmad Raza, Ben Marshall and Nuttawat Visaltanachoti run a horse race of four currency value strategies:

  1. Real Exchange Rate: nominal spot exchange rate with the U.S. dollar times the ratio of local consumer prices in local currency to U.S. consumer prices in U.S. dollars.
  2. Real Exchange Rate Change: one minus the ratio of the average real exchange rate between 5.5 and 4.5 years ago to the real exchange rate three months ago.
  3. Purchasing Power Parity: from the Organization for Economic Co-operation and Development (OECD).
  4. Big Mac Index: raw version from the Economist.

Their approach is to calculate excess returns in U.S. dollars from a portfolio that is iteratively long (short) the fifth of currencies that are most undervalued (overvalued) per each of these four metrics and hold the positions over periods ranging from one week to 12 months. Using weekly and monthly spot and forward foreign exchange rate data for 39 developed and emerging market currencies versus the U.S. dollar during January 1972 through July 2013, they find that: Keep Reading

Currency Carry Trade Over the Long Run

Does the currency carry trade, financing short-term deposits in currencies with high interest rates with short-term loans in currencies with low interest rates (or being long and short forward contracts in currencies with high and low interest rates) generate a reliably attractive return? In the November 2014 version of their paper entitled “Empirical Evidence on the Currency Carry Trade, 1900-2012”, Nikolay Doskov and Laurens Swinkels measure annual nominal and real carry trade returns for a large sample of currencies over a long period covering multiple currency regimes. They use yields on local Treasury bills (T-bills) or equivalents to approximate short-term interest rates and make some adjustments to account for government defaults. To estimate carry trade returns, they sort currencies each year based on associated T-bill yields and take equally weighted long (short) positions in the four currencies with the highest (lowest) yields. Using annual exchange rates and associated T-bill yields for 20 currencies during 1900 through 2012 (19 currencies before 1925 and 12 currencies after 1998), they find that: Keep Reading

Interplay of the Dollar, Gold and Oil

What is the interplay among investable proxies for the U.S. dollar, gold and crude oil? Do changes in the value of the dollar lead those in hard assets? To investigate, we relate the return series of three exchange-traded funds: (1) the futures-based PowerShares DB US Dollar Index Bullish (UUP); (2) the spot-based SPDR Gold Shares (GLD); and, (3) the spot-based United States Oil (USO). Using monthly, weekly and daily prices for these funds during March 2007 (limited by inception of UUP) through November 2014 (93 months), we find that: Keep Reading

Comprehensive, Long-term Test of Technical Currency Trading

Does quantitative technical analysis work reliably in currency trading? If so, where does it work best? In their May 2013 paper entitled “Forty Years, Thirty Currencies and 21,000 Trading Rules: A Large-Scale, Data-Snooping Robust Analysis of Technical Trading in the Foreign Exchange Market”, Po-Hsuan Hsu and Mark Taylor test the effectiveness of a broad set of quantitative technical trading rules as applied to exchange rates of 30 currencies with the U.S. dollar over extended periods. They consider 21,195 distinct technical trading rules: 2,835 filter rules; 12,870 moving average rules; 1,890 support-resistance signals; 3,000 channel breakout rules; and, 600 oscillator rules. They employ a test methodology designed to account for data snooping in identifying reliably profitable trading rules. They also test whether technical trading effectiveness weakens over time. In testing robustness to trading frictions, they assume a fixed one-way trading cost of 0.025%. Using daily U.S. dollar exchange rates for nine developed market currencies and 21 emerging market currencies during January 1971 through July 2011, they find that:

Keep Reading

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ETF Momentum Signal
for December 2015 (Final)

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Top 1 ETF Top 2 ETFs
12.0% 12.3%
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12.6% 7.4%
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ETF Value Signal
for December 2015 (Final)





The asset with the highest allocation is the holding of the Best Value strategy.
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