Grid trading is an automated currency trading strategy where an investor creates a so-called “price grid”. The basic idea of the strategy is to repeatedly buy at the pre-specified price and then wait for the price to rise above that level and then sell the position (and vice versa with shorting and covering). We will explore the basics and show favorable and unfavorable scenarios in the first article about this trading style. Later articles will dig deeper and investigate how Grid trading is related to other systematic trading strategies.

There are many ways one can lose money when investing, and exchange rates are one of the potential risk factors. Luckily, there are several ways to minimize this type of loss in your portfolio. Systematic FX hedging that uses currency factor strategies is a way of protecting an existing or anticipated position from an unwanted move in an exchange rate. It does not eliminate the risk of loss completely but helps to manage currency exposure better.

Bitcoin and other currencies are frequently discussed nowadays. The debate has emerged mainly because of the strong uptrend in the Bitcoin price. In this blog post, we will leave the price patters to others. We will instead present interesting novel research connected to the well known theoretical model in the fiat currencies – the Covered Interest Rate Parity (CIP). If the CIP holds, interest rates and both the spot and forward rates of two countries should be in equilibrium. Novel research of Franz and Valentin (2020) examines the CIP in BTC/USD pair. The CIP theory states that there should be no arbitrage opportunities, but how the CIP holds in such a volatile market, where individual investors/traders seem to dominate? According to research, there were significant CIP deviations in the past, but it changed with the launch of BTC/USD futures in CME and high-frequency traders’ market entry. Moreover, the second event was much more successful in the reduction of deviations.

The foreign exchange market (FOREX) is opened 24 hours a day, but traders from different parts of the world tend to prefer different trading hours. However, various dominant trading sessions around the globe can lead to time-dependent market characteristics. Novel research by Doman and Doman (2020) has studied how does the daily volatility of FX rates depend on the time of day of calculation. The volatility changes through the day, and the underlying dynamics depend on the time of the estimate. The results can have important implication for practitioners since the volatility differences are large enough so they can influence trading/risk management decisions.

Authors: Małgorzata Doman and Ryszard Doman

Title: How Does the Daily Volatility of Foreign Exchange Rates Depend on the Time of Day at Which the Daily Returns Are Calculated?

A lot of backtests of systematic trading strategies omit transaction costs (in the form of spreads and fees). Simulation is then simpler, but resultant model portfolio and its performance can be misleading. In the case of currency factor investing, backtest without the costs simulation can pick currencies with wider spreads and higher volatilities. And in real trading, with real-world transaction costs, a strategy can, therefore, perform significantly worse than expected. A research paper written by Melvin, Pan, and Wikstrom offers an elegant optimization methodology to incorporate transaction costs into the backtesting process which allows strategies to retain their alpha …

Authors: Michael Melvin, Wenqiang Pan, Petra Wikstrom

Title: Retaining Alpha: The Effect of Trade Size and Rebalancing Frequency on FX Strategy Returns

The United States has a special place in a global financial system. The U.S. dollar is the world’s reserve currency, and U.S. Treasuries are used as primary safe assets. Therefore, it is no surprise that the U.S. has some benefits from this arrangement. Academic research paper written by Krishnamurthy & Lustig shows that the U.S. derives a “convenience yield” from a demand of foreign investors. They consequently incur lower returns on their holdings of dollar-denominated safe assets. The FED’s conventional and unconventional monetary policy actions directly impact the supply of dollar-denominated safe assets. These decisions also affect the size of convenience yield, which causes moves in global financial markets…

Authors: Krishnamurthy, Lustig

Title: Mind the Gap in Sovereign Debt Markets: The U.S. Treasury basis and the Dollar Risk Factor