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Momentum and Trend Following Trading Strategies for Currencies Revisited – Combining Academia and Industry

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “Momentum and Trend Following Trading Strategies for Currencies Revisited – Combining Academia and Industry” authored by Janick Rohrbach, Silvan Suremann, and Joerg Osterrieder, undertakes a comprehensive re-examination of momentum trading strategies, a topic that is extensively expounded in academic literature and widely embraced in various trading methodologies adopted by hedge funds, asset managers, and proprietary traders.

The study delves into the meticulous delineation of a momentum trading strategy, elucidating the underpinnings of this approach with profound insights into the derivation of constants and parameters requisite for practical application. It meticulously expounds upon the computation of a trading signal as a blend of exponential moving averages with disparate time horizons and proffers a statistical rationale for the optimal selection of these time horizons.

Furthermore, the study’s ambit encompasses a rigorous evaluation of the proposed approach across global currency markets, encapsulating G10 currencies, emerging market currencies, and cryptocurrencies.

Notably, this study stands as the first exhaustive endeavor to delineate the intrinsic statistical tenets underpinning the construction of such trading strategies in the industry, supplemented by empirical evidence garnered from a vast currency universe, inclusive of cryptocurrencies.

Abstract Of Paper

Momentum trading strategies are thoroughly described in the academic literature and used in many trading strategies by hedge funds, asset managers, and proprietary traders. Baz et al. (2015) describe a momentum strategy for different asset classes in great detail from a practitioner’s point of view. Using a geometric Brownian Motion for the dynamics of the returns of financial instruments, we extensively explain the motivation and background behind each step of a momentum trading strategy. Constants and parameters that are used for the practical implementation are derived in a theoretical setting and deviations from those used in Baz et al. (2015) are shown. The trading signal is computed as a mixture of exponential moving averages with different time horizons. We give a statistical justification for the optimal selection of time horizons. Furthermore, we test our approach on global currency markets, including G10 currencies, emerging market currencies, and cryptocurrencies. Both a time series portfolio and a cross-sectional portfolio are considered. We find that the strategy works best for traditional fiat currencies when considering a time series based momentum strategy. For cryptocurrencies, a cross-sectional approach is more suitable. The momentum strategy exhibits higher Sharpe ratios for more volatile currencies. Thus, emerging market currencies and cryptocurrencies have better performances than the G10 currencies. This is the first comprehensive study showing both the underlying statistical reasons of how such trading strategies are constructed in the industry as well as empirical results using a large universe of currencies, including cryptocurrencies.

Original paper – Download PDF

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Author

Janick Rohrbach
Zurich University of Applied Sciences

Silvan Suremann
Zurich University of Applied Sciences

Joerg Osterrieder
University of Twente; Bern Business School

Conclusion

In summation, the research paper “Momentum and Trend Following Trading Strategies for Currencies Revisited – Combining Academia and Industry” spearheaded by Janick Rohrbach, Silvan Suremann, and Joerg Osterrieder, heralds a seminal contribution that brings forth a revisitation of momentum trading strategies, an area that pervades academic literature and forms the linchpin of numerous trading frameworks adopted by prominent players in the financial sphere.

This comprehensive study artfully demystifies the intricacies of a momentum trading strategy, unraveling the foundational tenets while providing nuanced insights into the derivation of constants and parameters critical for the practical implementation of this approach.

The study also furnishes a cogent statistical rationale for the optimal selection of time horizons, thereby disseminating indispensable knowledge pivotal for the efficacious execution of momentum trading strategies.

Furthermore, the empirical evaluation navigates through the labyrinth of the global currency market and cryptocurrencies, illuminating the superior efficacy of the strategy for traditional fiat currencies, particularly when underpinned by a time series-based momentum approach.

Noteworthy is the revelation that the momentum strategy manifests higher Sharpe ratios for more volatile currencies, thus catapulting emerging market currencies and cryptocurrencies to the forefront.

Symbolizing a seminal milestone, this pioneering study represents the first profound foray into uncovering the latent statistical tenets that underpin the instantiation of trading strategies in the industry, bolstered by empirical evidence stemming from an expansive pantheon of currencies, inclusive of cryptocurrencies.

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FAQ

Q1: What is the focus of the research paper “Momentum and Trend Following Trading Strategies for Currencies Revisited – Combining Academia and Industry”?

A1: The research paper focuses on revisiting momentum trading strategies, a topic extensively covered in academic literature and widely utilized in trading methodologies by hedge funds, asset managers, and proprietary traders. The study aims to provide a comprehensive understanding of the construction of momentum trading strategies, deriving constants and parameters for practical implementation.

Q2: What is the methodology used in the paper to explain the momentum trading strategy?

A2: The paper extensively explains the motivation and background behind each step of a momentum trading strategy. It uses a geometric Brownian Motion for the dynamics of the returns of financial instruments. The study delves into the derivation of constants and parameters in a theoretical setting and provides a statistical justification for the optimal selection of time horizons, which are crucial for computing the trading signal.

Q3: How does the paper evaluate the proposed momentum trading strategy?

A3: The paper tests the proposed momentum trading strategy on global currency markets, including G10 currencies, emerging market currencies, and cryptocurrencies. Both a time series portfolio and a cross-sectional portfolio are considered in the evaluation. The study finds that the strategy works best for traditional fiat currencies when considering a time series-based momentum strategy. For cryptocurrencies, a cross-sectional approach is deemed more suitable.

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