Economics, Econometrics and Finance
8 years ago

Trend following strategy offers significant hedge against market risks in forex.

SSRN Electronic Journal
Carry and Trend Following Returns in the Foreign Exchange Market
Andrew Clare, James Seaton, Peter N. Smith, Steve Thomas

Paper Summary

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Traders can make money in the foreign exchange market by following two strategies: the carry trade and trend following. The carry trade involves buying currencies with high interest rates and selling those with low rates, while trend following buys currencies with positive returns. Market risk affects carry trade returns, but the traditional CAPM model doesn't fully explain them. A new model that considers market liquidity does a better job. Trend following also helps hedge against risks in the market. Surprisingly, trend following doesn't have the same downside risks as the carry trade.