Tearing Your Hair Out?

Adam Lemon

These days I am fortunate enough to struggle with the issue of whether I make as much profit as I “should”. When I was starting out as a trader, and this might be familiar to some of you, I struggled with trying to break even, let alone actually pocketing any profit. I tried a whole lot of stuff and would arrive at a “tearing my hair out” moment where I wanted to yell “Can somebody just tell me what the hell works???”

If this describes how you are feeling right now about your trading, then I can tell you something that does work, statistically speaking – following trends. That might sound dull or boring, but maybe the problem is really that everyone has a different definition of what a “trend” is. It can actually be extremely simple.

What really influenced me to go in this direction was finding some academic research papers which seemed to prove that just buying currencies that had been going up and selling currencies going down produced pretty good returns over a recent multi-year period. One of the best studies performed the following experiment:

1. Each month, they looked at the exchange rates of more than 40 currencies against the U.S. Dollar. Historical data from 1976 to 2010 was examined.

2. The currency that had risen the most against the USD over defined look-back periods (1 month, 3 months and 6 months) was bought and held for one month.

3. The currency that had fallen the most against the USD over defined look-back periods (1 month, 3 months and 6 months) was sold and held for one month.

4. The average return (not accounting for trading costs) was about 7.50% per year. This may not sound like a great deal, the issue here is really whether there is a mathematical strategy that has a positive expectancy over a large data sample, and the study seemed to show this is indeed the case.

This is actually a “best of” momentum strategy, where assets with the most positive or negative extreme performances are selected and followed in that same direction of performance.

I am not convinced that this strategy has performed as well since 2010 as is claimed for the 24-year period leading up to it, as the major trends of the past few years have been driven by fluctuations in the U.S. Dollar rather than other currencies, and the strategy outlined above is U.S. Dollar neutral. However, I will check this against historical data since 2010 and see how the strategy would have performed, and report detailed hypothetical results at a later date.

A final word – “time series” momentum strategies generally work even better than “best of” momentum strategies. In “time series”, you just buy X asset if it is up or sell it if it is down without reference to any other asset. More about this another time.

Adam Lemon

Adam Lemon began his role at DailyForex in 2013 when he was brought in as an in-house Chief Analyst. Adam trades Forex, stocks and other instruments in his own account. Adam believes that it is very possible for retail traders/investors to secure a positive return over time provided they limit their risks, follow trends, and persevere through short-term losing streaks – provided only reputable brokerages are used. He has previously worked within financial markets over a 12-year period, including 6 years with Merrill Lynch.
Learn more from Adam in his free lessons at FX Academy

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