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Lessons from the evolution of foreign exchange trading strategies

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  • Neely, Christopher J.
  • Weller, Paul A.

Abstract

The adaptive markets hypothesis posits that trading strategies evolve as traders adapt their behavior to changing circumstances. This paper studies the evolution of trading strategies for a hypothetical trader who chooses portfolios from foreign exchange (forex) technical rules in major and emerging markets, the carry trade, and US equities. The results show that a backtesting procedure to choose optimal portfolios improves upon the performance of nonadaptive rules. We also find that forex trading alone dramatically outperforms the S&P 500, with much larger Sharpe ratios over the whole sample, but there is little gain to coordinating forex and equity strategies, which explains why practitioners consider these tools separately. Forex trading returns dip significantly in the 1990s but recover by the end of the decade and have been markedly superior to an equity position since 1998. Overall, trading rule returns still exist in forex markets—with substantial stability in the types of rules—though they have migrated to emerging markets to a considerable degree.

Suggested Citation

  • Neely, Christopher J. & Weller, Paul A., 2013. "Lessons from the evolution of foreign exchange trading strategies," Journal of Banking & Finance, Elsevier, vol. 37(10), pages 3783-3798.
    • Handle: RePEc:eee:jbfina:v:37:y:2013:i:10:p:3783-3798
    DOI: 10.1016/j.jbankfin.2013.05.029
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    More about this item

    Keywords

    Exchange rate; Technical analysis; Technical trading; Carry trade; Efficient markets hypothesis; Adaptive markets hypothesis;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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