Profitability and Price Effects of Technical Currency Trading

Abstract

The study investigates profitability and price effects of 1024 moving average and momentum models in the DM/dollar market (1973/99) as well as in the yen/dollar market (1976/99). The main results are as follows. First, each of these models would have produced an positive return over the entire sample period. The probability of making an overall loss when strictly following one of these models would have been close to zero. Second, this profitability is exclusively due to the exploitation of persistent exchange rate trends around which the daily rates fluctuate. Third, these results do not change substantially when technical currency is simulated over subperiods. Fourth, the out-of-sample profitability of those models which performed best in sample (i.e., over the most recent subperiod) is slightly higher than the average in-sample profitability of all models. However, the ex-post best models perform much worse out of sample than in sample. Fifth, the aggregate transactions and positions of technical models exert an excessive demand (supply) pressure on currency markets. Sixth, there is a strong feed-back mechanism operating between exchange rate movements and the transactions triggered off by technical models. A rising exchange rate, for example, causes increasingly more technical models to produce buy signals, which in turn strengthen and lengthen the appreciation trend.