Combining mean reversion and momentum trading strategies in foreign exchange markets

The literature on equity markets documents the existence of mean reversion and momentum phenomena. Researchers in foreign exchange markets find that foreign exchange rates also display behaviors akin to momentum and mean reversion. This paper implements a trading strategy combining mean reversion and momentum in foreign exchange markets. The strategy was originally designed for equity markets, but it also generates abnormal returns when applied to uncovered interest parity deviations for five countries. I find that the pattern for the positions thus created in the foreign exchange markets is qualitatively similar to that found in the equity markets. Quantitatively, this strategy performs better in foreign exchange markets than in equity markets. Also, it outperforms traditional foreign exchange trading strategies, such as carry trades and moving average rules.     

Can technical trading beat the foreign exchange market in times of crisis?

I examine the profitability of three simple foreign exchange technical trading rules (moving average, momentum, and relative strength index) before, during, and after the 2007–2008 global financial crisis. These rules significantly improve profitability during the crisis (as opposed to before and after it). The moving average rule significantly increases profitability for exchange rate changes during the crisis. The momentum and relative strength index rules generate significant positive excess currency returns (defined as the difference between the forward premium and spot rate changes), but this profitability is not visible in spot rate changes. These findings are robust for portfolios of developed and emerging market currencies as well as for bilateral exchange rates.     

Trend-following trading strategies in commodity futures: A re-examination

This paper examines the performance of trend-following trading strategies in commodity futures markets using a monthly dataset spanning 48 years and 28 markets. We find that all parameterizations of the dual moving average crossover and channel strategies that we implement yield positive mean excess returns net of transactions costs in at least 22 of the 28 markets. When we pool our results across markets, we show that all of the trading rules earn hugely significant positive returns that prevail over most subperiods of the data as well. These results are robust with respect to the set of commodities the trading rules are implemented with, distributional assumptions, data-mining adjustments and transactions costs, and help resolve divergent evidence in the extant literature regarding the performance of momentum and pure trend-following strategies that is otherwise difficult to explain.     

Fuzzy logic,trading uncertainty and technical trading

From the market microstructure perspective, technical analysis can be profitable when informed traders make systematic mistakes or when uninformed traders have predictable impacts on price. However, chartists face a considerable degree of trading uncertainty because technical indicators such as moving averages are essentially imperfect filters with a nonzero phase shift. Consequently, technical trading may result in erroneous trading recommendations and substantial losses. This paper presents an uncertainty reduction approach based on fuzzy logic that addresses two problems related to the uncertainty embedded in technical trading strategies: market timing and order size. The results of our high-frequency exercises show that ‘fuzzy technical indicators’ dominate standard moving average technical indicators and filter rules for the Euro-US dollar (EUR-USD) exchange rates, especially on high-volatility days.     

Chasing trends: recursive moving average trading rules and internet stocks

The recent rise and fall of Internet stock prices has led to popular impressions of a speculative bubble in the Internet sector. We investigate whether investors could have exploited the momentum in Internet stocks using simple moving average (MA) trading rules. We simulate real time technical trading using a recursive trading strategy applied to over 800 moving average rules. Statistical inference takes into account conditional heteroscedasticity and joint dependencies. No evidence of significant trading profits is found. Most Internet stocks behave as random walks; this, combined with high volatility, may be the reason for the dismal performance of the moving average rules.     

Technical analysis: An asset allocation perspective on the use of moving averages

In this paper, we analyze the usefulness of technical analysis, specifically the widely employed moving average trading rule from an asset allocation perspective. We show that, when stock returns are predictable, technical analysis adds value to commonly used allocation rules that invest fixed proportions of wealth in stocks. When uncertainty exists about predictability, which is likely in practice, the fixed allocation rules combined with technical analysis can outperform the prior-dependent optimal learning rule when the prior is not too informative. Moreover, the technical trading rules are robust to model specification, and they tend to substantially outperform the model-based optimal trading strategies when the model governing the stock price is uncertain.     

Trend‐Following Trading Strategies in U.S. Stocks: A Revisit

We show that previous findings regarding the profitability of trend‐following trading rules over intermediate horizons in futures markets also extend to individual U.S. stocks. Portfolios formed using technical indicators such as moving average or channel ratios, without employing cross‐sectional rankings of any kind, tend to perform about as well as the more commonly examined momentum strategies. The profitability of these strategies appears significant, both statistically and economically, through 2007, but evidence of profitability vanishes after 2007. Market‐state dependence, while clearly present, does not explain the post‐2007 reduction in returns to these strategies.     

Is the Swedish stock market efficient? Evidence from some simple trading rules

In this paper we examine the profitability of some technical trading rules in the Swedish stock market over the 1986-2004 periods. The results indicate that moving average rules do indeed have predictive power and could discern recurring-price patterns for profitable trading, even after accounting for the effects of data snooping biases. To assess the profitability of different technical trading rules and strategies, we adopt White's [White, H. (2000). A Reality Check for data snooping, Econometrica, 68, 1097-1126.] Reality Check test that quantifies the data snooping bias adjusting for its effects. Our results also support the hypothesis that technical trading rules can outperform the buy-and-hold strategy even considering transaction costs.     

How profitable are FX technical trading rules?

This paper provides a comprehensive empirical investigation of the profitability of foreign exchange technical trading rules over the 1996:10–2015:06 period for 22 currencies quoted in US dollars. It reports evidence of profitability across a universe of 113,148 rules that include traditional moving average rules and those constructed on the basis of technical indicators such as Bollinger bands and the relative strength index. The best trading rules achieve annualised returns of up to 30%. The Step-SPA test (Hsu, Hsu, & Kuan, 2010) results show a sharp fall in the total number of rules that are robust to data snooping bias. Virtually no traditional rule is significant in the 2006–2015 sub-sample, in line with the adaptive market hypothesis. By contrast, rules based on new technical indicator such as Bollinger band and relative strength index rules remain robustly profitable across all currencies over the more recent sub-sample.     

Currency momentum strategies

We provide a broad empirical investigation of momentum strategies in the foreign exchange market. We find a significant cross-sectional spread in excess returns of up to 10% per annum (p.a.) between past winner and loser currencies. This spread in excess returns is not explained by traditional risk factors, it is partially explained by transaction costs and shows behavior consistent with investor under- and overreaction. Moreover, cross-sectional currency momentum has very different properties from the widely studied carry trade and is not highly correlated with returns of benchmark technical trading rules. However, there seem to be very effective limits to arbitrage that prevent momentum returns from being easily exploitable in currency markets.     

Limited investor attention,relative fundamental strength,and the cross-section of stock returns

We explore the underlying reasons for the apparent mispricing of firms based on fundamental information. We document that a relative fundamental strength strategy that buys (sells) firms with strong (weak) fundamentals is highly profitable for up to three years. The results cannot be explained by either price or earnings momentum, are robust to risk adjustments based on standard asset pricing models, and survive a battery of robustness tests. The strategy also works better among small firms, as well as firms with low analyst coverage and a high probability of informed trading. Our empirical findings support the hypotheses of limited investor attention and informed trading.     

Trend following with momentum versus moving averages: a tale of differences

Despite the ever-growing interest in trend following and a series of publications in academic journals, there is a dearth of theoretical results on the properties of trend-following rules. Our paper fills this gap by comparing and contrasting the two most popular trend-following rules, the momentum (MOM) and moving average (MA) rules, from a theoretical perspective. We provide theoretical results on the similarity between different trend-following rules and the forecast accuracy of trading rules. Our results show that the similarity between the MOM and MA rules is high and increases with the strength of the trend. However, compared to the MOM rule, the MA rules exhibit more robust forecast accuracy for the future direction of price trends. In this paper, we also develop a hypothesis about uncertain market dynamics. We show that this hypothesis, coupled with our analytical results, has far-reaching practical implications and can explain a number of empirical observations. Among other things, our hypothesis explains why the empirical performance of the MA rules is better than that of the MOM rule. We broaden the appeal and practical importance of our theoretical results by offering various illustrations and real-world examples.     

Are good-news firms riskier than bad-news firms?

This paper examines the relative risk of good-news firms, i.e., those with high standardized unexpected earnings (SUE), and bad-news (low SUE) firms using a stochastic discount factor approach. We find that a stochastic discount factor constructed from a set of basis assets helps explain post-earnings-announcement drift (PEAD). The risk exposures on the pricing kernel increase monotonically from the lowest to highest SUE sorted portfolios. Specifically, good-news firms always have higher risk exposures than bad-news firms in both 10 SUE sorted portfolios and 25 size and SUE sorted portfolios. However, the estimated expected risk premium is too small to explain the observed magnitude of returns on the PEAD strategy. Our risk adjustment can explain only about one-fourth of the total magnitude of the average realized return to the PEAD strategy. As a result, the average risk-adjusted returns of earnings momentum strategies are mostly positive and significant. Overall, our results support the view that at least some portion of the returns to the earnings momentum strategies examined represent compensation for bearing increased risk.     

Exchange trading rules and stock market liquidity

We examine stock exchange trading rules for market manipulation, insider trading, and broker–agency conflict, across countries and over time, in 42 stock exchanges around the world. Some stock exchanges have extremely detailed rules that explicitly prohibit specific manipulative practices, but others use less precise and broadly framed rules. We create new indices for market manipulation, insider trading, and broker–agency conflict based on the specific provisions in the trading rules of each stock exchange. We show that differences in exchange trading rules, over time and across markets, significantly affect liquidity.     

The Post‐Cost Profitability of Momentum Trading Strategies: Further Evidence from the UK

This paper examines the post‐cost profitability of momentum trading strategies in the UK over the period 1988–2003 and provides direct evidence on stock concentration, turnover and trading cost associated with the strategy. We find that after factoring out transaction costs the profitability of the momentum strategy disappears for shorter horizons but remains for longer horizons. Indeed, for ranking and holding periods up to 6‐months, profitable momentum returns would not be available to most average investors as the cost of implementation outweighs the possible returns. However, we find post‐cost profitability for ranking and/or holding periods beyond 6 months as portfolio turnover and its associated cost reduces. We find similar results for a sub‐sample of relatively large and liquid stocks.     

Challenging the robustness of optimal portfolio investment with moving average-based strategies

The aim of this paper is to compare the performance of a theoretically optimal portfolio with that of a moving average-based strategy in the presence of parameter misspecification. The setting we consider is that of a stochastic asset price model where the trend follows an unobservable Ornstein–Uhlenbeck process. For both strategies, we provide the asymptotic expectation of the logarithmic return as a function of the model parameters. Then, numerical examples are given, showing that an investment strategy using a moving average crossover rule is more robust than the optimal strategy under parameter misspecification.     

On market efficiency of Asian foreign exchange rates: evidence from a joint variance ratio test and technical trading rules

This study employs a joint variance ratio test and technical trading rules to examine the random walk behavior for nine Asian foreign exchange rates for the period 1988–1995. The joint variance ratio test results suggest that there is little evidence of serial correlations in the daily exchange rate series. The results also indicate that, in general, the moving average and channel trading rules do not generate significant, positive profits.     

On the Stability of the Cross‐Section of Expected Stock Returns in the Cross‐Section: Understanding the Curious Role of Share Turnover

In this paper, we shed further light on cross‐sectional predictors of stock return performance. Specifically, we explore whether the cross‐section of expected stock returns is robust within stock groups sorted by past monthly return. We find that the book/market and momentum effects are remarkably robust to sorting on past returns. However, share turnover is negatively related to future returns for stocks with abnormally low stock price performance in the recent past, but postively related to returns for well‐performing stocks. This casts doubt on the use of turnover as a liquidity proxy, but is consistent with turnover being a proxy for momentum trading which pushes prices in the direction of past price movements. Our results are robust to both NYSE/AMEX and Nasdaq stocks, and also robust to stratifying the sample by time period.     

动量交易策略及我国股票市场实证分析

动量交易策略指的是事先针对股票收益及交易量设定过滤规则,一旦股票收益或者股票收益和交易量同时满足过滤规则就买入或卖出股票的交易策略。动量交易策略的理论基础是行为金融学。国外投资者已经成功地在实践中应用了该策略。我国股票市场是否存在动量效应,还未形成统一的结论。在总结国内外学者研究方法的基础上,利用目前可用的数据,对我国股票市场在中期条件下动量交易策略的适用性进行了实证研究。但得出的结论并不支持存在动量效应。     

A new strategy using term-structure dynamics of commodity futures

The term structure of commodity futures is important information for traders and investors. Traditional term-structure strategies are static; they tend to use the slope of term structure at a given moment. Instead, our trading strategy uses the change of term structure and generates statistically significant return. It also produces significant abnormal return in excess of the traditional two factors, i.e. the returns from static-slope strategy and daily momentum. Thus, its return includes orthogonal information or excess return that standard static-slope and momentum strategies cannot explain. This suggests a novel risk factor in the asset class of commodity futures or robust trading opportunities.