Performance of Currency Trading Strategies in Developed and Emerging Markets: Some Striking Differences

Abstract

Expanding the currency investment universe makes a lot of sense from a diversification point of view. Nevertheless, 60% of the total foreign exchange turnover is still only traded in three currency pairs (USD/EUR, USD/JPY and USD/GBP). The share of trading in local currencies in emerging markets is only around 5%. This can be explained by the fact that some currency managers fear investing in emerging market currencies. Many believe that political risk is the most dominant driver in these markets and that traditional investment rules do not work. In this paper, I apply four technical trading strategies for the developed market currencies and for the most traded emerging market currencies. The empirical results show some striking differences. They suggest that trend-following rules work better for emerging market currencies, while carry trading strategies perform better across developed market currencies. Nevertheless, it seems that conventional techniques could be successfully applied to both developed and emerging market currencies. I conclude that currency managers should not be afraid to diversify into emerging market currencies. They should, however, adjust their trading style accordingly.