Different markets react in different ways to trends. Self-described "momentum players" in equities are regarded with suspicion by value investors and those who pay attention to folderol such as balance sheets and income statements. Such disdain in the world of currency trading is rare, however, as traders learned the hard way a long time ago just how right Isaac Newton was: Markets in motion tend to stay in motion and markets at rest tend to stay at rest.
This is so for a very good reason. Currencies reflect long-term national policies and tendencies slow, if not impossible, to change; these include monetary policies that tend to persist. For example, when the Federal Reserve acts to loosen or tighten credit, it does so over a lengthy period of time. If these cycles are out of phase with those of other central banks, and they have been between the U.S. and the Eurozone for some time now, the dollar will strengthen or weaken accordingly.
But two problems arise. The average annual excess return for ABN-AMRO's index trend-following currency traders since the end of 1986 has been 3.8%, with a near-zero Sharpe ratio of 0.03. Such performance raises the question, "Why bother?" Second, are all currencies created equal in their trendiness?
The Trend Is Your Friend ... Maybe
Wall Street has a bit of doggerel for every situation. Here, it is, "The trend is your friend except for the bend in the end." Once a trend gets moving and the trade gets crowded, all it takes to make everyone scramble for the exits is ... anything. And I do mean anything; who has not seen weeks of profits evaporate in an execution vacuum on the slightest bit of questionable news? As this melodrama is part of human nature, we can consider it to be a permanent feature of the trading landscape.
Technical Analysis Gold Regains Its Luster 7/14/2008 3:59 PM EDT The dollar is helping gold return to its highs.
Technical Analysis Cisco as a Value Play 7/14/2008 3:40 PM EDT The shares haven't been cheaper, and potential catalysts abound.
Technical Analysis Fitz Bits: Absolutely No Reason to Be in EMC 7/14/2008 12:59 PM EDT If you were in it a few months ago, terrific. If you're in it now, you're in big trouble.
Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.
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