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Jonathan Tunney, CFA
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Jonathan Tunney, CFA is the managing principal of Atlas Capital Advisors LLC, a fee-based investment advisor based in San Francisco, with clients across the country. Atlas Capital Advisors manages both ‘risk’ and ‘conservative’ assets on an individual account basis with assets custodied... More
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  • Currency Trading - Momentum trading in the G10

    There are two types of people that trade short term currency positions, those that know that they don't know where the market is headed and those that don't know that they don't know where the market is headed.   The former group, to which I belong, is a minority of currency traders and you only arrive in this camp after years of successes and failures in attempting to understand short term currency movements.

    To those of you that strongly feel that you truly have some unique insight, you'd better skip this article and get back to 'tick watching'.   You have many years of education ahead of you and there are plenty of other articles that talk about where currences are headed based on 'fundamentals'.  

    In fact, while working as the Director of FX risk management at Hewlett Packard, we did a study of all the head currency strategists for the money center banks.   We looked at their forecasts over a long periods and across many currency pairs and guess what?  They stunk.. if fact, on average they were worse that 50% in picking winning trades.

    All that being said... there are profitable ways to trade currencies.   The argument for trading currencies for profit is that there are many nonprofit seeking participants in the FX markets (governments, corporations, tourists, etc).   Therefore, profit seeking participants in this asset class will have an advantage not enjoyed by those trading equities or fixed income

    Most successful currency trading strategies have longer term signals.   One of the most often utilized signals for technical traders is the momentum signal.   However, I can offer one unique insight to momentum trading in currencies: momentum doesn't work in the G10.   

    During the many years we worked to develop FX trading models, we attempted to determine the optimum 'lag' for trading momentum (more on that later).   In the case of a simple moving average signal, this translates into the number of days that you should use in your models.

    Interestingly enough, we constructed the following graph (sorry for the eye chart here, I will tell you what it says)

    Basically, the graph is the 'information ratio' (excess return / risk) of trading different currencies by number of moving average days.   The x axis starts at zero and goes all the way to a 200 day moving average.   On the y axis, we have various currencies.   The G10 currencies are on the left and the 'E14' are on the right (there is no such thing as 'E14' other than in the tortured world of FX risk managers.  These are the 'other' currencies that usually cost you a arm and a leg to trade and tend to be very illiquid or only accessible using non deliverable forwards (NDFs)).

    The color bar on the right shows the level of information contain in the combination of the currency pair and frequency of the signal.  Red and yellow is good. Light and dark blue is bad.

    Take a step back and what do you see?   Other than a brief medium term signal with JPY, the G10 currencies just don't have very much information with respect to momentum signals while the E14 currencies have a ton of information.  

    Why is this?  Our theory is that the currencies where there is a very small percentage of profit seekers (i.e. currencies where there are NO liquid forward contracts) and high participation of nonprofit seeking participants tend to 'trend' and you can have a profitable trading strategy almost regardless of the frequency of your momentum signal. (and this theory even accommodates the exception for JPY being a profitable momentum currency to trade due to the BOJ intervention over the decades).

    (What is the optimum lag?  On the very right of the chart you can see that the mean and median most profitable number of days to trade currencies is a bit less than 50.)

    By the way, never trade single currency ETFs and never trade anywhere other than the CME.   You are just asking to have your face ripped off.

    Disclosure: Long RUR, Long ZAR, Long BRL, Short EUR, Short CNY
    May 10 10:58 PM | Link | Comment!
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