The performance of technical trading rules

Extract: S. Schulmeister working paper (Dec 2005)

Which properties of technical trading systems account for their popularity among currency traders? The analysis is based on the performance of 1024 moving average and momentum models in the single most active foreign exchange market, the DM/$ market between 1973 and 1999. An out-of-sample test of the performance of all 1024 models between 2000 and 2004 (euro/US dollar) completes this part of the study. The main results are as follows:

  • Each of these models would have been profitable over the entire sample period, 91.7% would have remained profitable between 2000 and 2004.
  • The number of profitable trades is lower than the number of unprofitable trades.
  • The average return per day during profitable positions is smaller than the average loss per day during unprofitable positions.
  • Profitable positions last 3 to 5 times longer than unprofitable positions. Hence, the overall profitability of technical currency trading is exclusively due to the exploitation of persistent exchange rate trends.
  • The best performing models optimize the duration of profitable positions relative to the duration of unprofitable positions.

This pattern reflects the general property of technical trading models: The profits from the exploitation of relatively few persistent price trends exceed the losses from many but small price fluctuations (“cut losses short and let profits run”).