A momentum trading strategy based on the low frequency component of the exchange rate




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A momentum trading strategy based on the low frequency component of the exchange rateFatih Yilmaz

Xfi Centre For Financial & Investment Working Paper No. 08/04

In this paper, we develop a momentum trading strategy based on the low frequency trend component of the spot exchange rate. Using, alternately, kernel regression and the high-pass filter of Hodrick and Prescott (1997), we recover the non-linear trend in the monthly exchange rate and use short-term momentum in this to generate buy and sell signals. The low frequency momentum trading strategy offers greater directional accuracy, higher returns and Sharpe ratios and lower maximum drawdown than traditional moving average rules. Moreover, unlike traditional moving average rules, the performance of the low frequency momentum trading strategy is relatively robust across different time periods, and to the choice of smoothing parameters across a wide range of values.

Number of Pages in PDF File: 30

Keywords: Momentum, Moving average rules, Hodrick-Prescott filter, Kernel regression, Trading strategy