Forex course · Section 5: Risk, Strategy and Testing
Forex Trading Strategies: Trend Following, Carry, Value and Momentum
The four classic currency strategy styles, how each one is built, why trend following has struggled in currencies since about 2010, and what testing shows.
Advanced6 min read·5:29 video·Lesson 21 of 26·quiz: 4 questions
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Most systematic forex strategies fall into four families: trend following (buy pairs that are rising, sell those falling), carry (hold high-interest currencies against low-interest ones), value (buy currencies that look cheap against a long-run fair value) and momentum (buy the currencies that have been strongest recently against the weakest). Each has a logical story and a body of research behind it, but trend following has struggled in currencies since about 2010, and none of them is a reliable money-maker for retail traders after costs. DanioX's own tests on the 28 major and cross pairs back that up, which is why the site currently publishes no forex signals.
Trend following
Trend following assumes that big moves, once started, tend to continue for a while, because economic forces such as diverging interest rates play out over months and many investors react slowly.
A typical daily rule set:
- Entry: buy when the close makes a new 20-day (or 55-day) high; sell short on a new 20-day low. Alternatively, follow a moving-average rule such as the 50-day average above the 200-day.
- Stop: 2 to 3 × ATR from entry (see Stop-Loss and Risk:Reward).
- Exit: a trailing stop, or an opposite 10-day or 20-day breakout.
- Size: the same fixed risk per trade, so volatile pairs get smaller positions.
What it feels like: most trades lose small amounts as breakouts fail; a few trades catch big moves and pay for everything. Long flat or losing stretches are normal.
Example
For illustration only: a system wins 35% of trades with an average win of +3R and an average loss of −1R. Expectancy = 0.35 × 3 − 0.65 × 1 = +0.40R. If the market stops producing long trends and the average win falls to +1.8R, expectancy becomes 0.35 × 1.8 − 0.65 = −0.02R. Trend following lives or dies on the size of the rare big winners.
Why trend following has struggled in currencies since about 2010
Trend rules did well in currencies in many earlier decades, and the history of famous trend-following traders is full of currency trades. Since roughly 2010 the picture in the major pairs has been much weaker. Explanations commonly offered include:
- Low and similar interest rates across major economies for much of the 2010s, which reduced the long-lasting rate divergences that drive currency trends.
- Heavy central bank involvement: forward guidance, bond buying and occasional intervention cut some moves short and caused sharp reversals.
- Lower volatility for long stretches, so moves were smaller relative to costs.
- More competition: trend rules are widely known and widely used, which may arbitrage away part of the effect.
Some periods, such as years when central banks moved rates far apart, were kinder to trend followers. But the long run of disappointing results in currencies is well documented, and you should not assume the earlier decades will return.
Carry
As explained in Swaps, Rollover and the Carry Trade, carry means holding high-yielding currencies against low-yielding ones and collecting the interest gap.
A typical rule set: rank the eight majors by short-term interest rates each month; go long the top two or three, short the bottom two or three, in equal risk.
Profile: steady income punctuated by sharp crashes when risk appetite collapses. The return depends heavily on what your broker actually pays and charges in swaps, which can be much less generous than the central bank rates suggest.
Value
Value strategies estimate where an exchange rate "should" be and bet on a slow return towards it. The classic yardstick is purchasing power parity (PPP): over the long run, the same basket of goods should cost about the same everywhere once converted. The Economist's Big Mac Index is a light-hearted version of this idea.
A typical rule set: compare each currency's real exchange rate (adjusted for inflation) with its long-run average; buy the most undervalued, sell the most overvalued; rebalance monthly or quarterly.
Profile: deviations from fair value can last for years, so value can lose for a long time before working. It suits patient, low-turnover portfolios, not short-term trading.
Momentum (cross-sectional)
Momentum here means relative strength: rank currencies by their return over the past 3 to 12 months, buy the strongest and sell the weakest, and rebalance monthly. It differs from trend following, which looks at each pair on its own. A currency strength ranking, like the one on the forex market page, is a short-term version of the same idea (see The US Dollar Index and Currency Strength).
Profile: works when leadership persists; suffers sharp losses at turning points, when yesterday's strongest currencies become today's weakest.
Combining styles
Academic research, such as the widely cited paper Value and Momentum Everywhere (Journal of Finance, 2013), found that value and momentum tended to perform at different times across many markets, including currencies. Combining styles can therefore smooth results. But mixing several weak or unprofitable strategies does not create a profitable one; it only makes the losses arrive more smoothly.
What testing shows
Pro note
DanioX tests textbook versions of these ideas on the 28 major and cross pairs with daily data from 2005, charging spreads and swaps, trading both long and short, and checking each one across different periods and with doubled costs. In those tests, the trend-following rules and the classic carry, value and momentum styles all failed to make robust money after costs and swaps. Some looked good in certain years and poor in others, which is what you would expect from luck rather than a durable edge. Because none passed, DanioX currently publishes no forex signals. The method and the published strategy tests, trade by trade, are on the forex backtest page, and the testing rules on the methodology page.
What this means for you:
- Do not buy a "proven" forex strategy on the strength of a chart or a good year. Ask for long, cost-inclusive tests on many pairs.
- Expect that most simple rules fail after realistic costs. That is normal, not a sign you missed a secret.
- If you trade anyway, keep risk small, treat it as an experiment, and keep records good enough to tell skill from luck.
Risk
A strategy that worked for a decade can stop working for the next one. Size every system on the assumption that its future will be worse than its backtest.
Next: how to test any of these ideas yourself without fooling yourself, in How to Backtest a Forex Strategy.
Key takeaways
- Trend following buys pairs making new highs and sells those making new lows; it wins rarely but aims for large wins.
- Carry, value and momentum are the classic currency 'styles': interest income, long-run fair value, and recent relative strength.
- Trend following in currencies has had a much harder time since about 2010 than in earlier decades.
- DanioX's own tests found that neither trend rules nor carry, value or momentum made robust money on the 28 major pairs since 2005 after costs and swaps, so no forex signals are published at present.
Quiz: check what you learned
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