Trading systems have shown success in the currency market by using the momentum strategy, which has proven effective across different types of assets, including foreign exchange. This tactic involves investing in currencies that have performed well in the past (winners) and betting against those that have not performed well (losers). Studies suggest that currencies with recent strong performance continue to outperform significantly compared to those with recent poor performance. This phenomenon can be attributed to factors like investors not reacting enough to new information, following the crowd and overreacting or underreacting to market movements. The strategy’s success is also tied to global economic risk, as higher returns are seen during high risk periods compared to low risk ones. Not only is this approach straightforward, but it can also act as a safeguard against stock market declines because of its minimal correlation with traditional stock market factors.

3 Factors for Trading System Outperformance

1. Adjusting Momentum Strategies
The strategy of momentum, which involves investing in past winners and betting against past losers, has proven to be quite promising in the realm of currency trading. This approach thrives on the continuation of trends in currency values and can be especially effective during times of global economic uncertainty or heightened market fluctuations. The success of this method stems from investors tendency to not fully react to new information and their behavioral tendencies like following the crowd or overreacting.

2. Utilizing Equal Weighted Indices
In various global equity markets, including those related to currencies, equal weighted indices have shown better performance compared to capitalization weighted ones. This outperformance can be attributed to the inherent biases toward smaller sizes and momentum that are typically present in equal weighted equity indices. This strategy is considered ideal for investors seeking returns but lacking strong stock picking abilities, indicating its potential usefulness in currency trading strategies for portfolio diversification and stability.

3. Factor Performance Across Macroeconomic Scenarios
Studies conducted within the Indian stock market have revealed that factors such as low volatility, quality, value, momentum and small cap size tend to outperform across different economic cycles, market phases and investor sentiment environments.

This suggests that comparable factor based strategies could be utilized in the realm of currency trading, leveraging these factors to maneuver across different economic scenarios and to execute proactive strategies or combine multiple factors in portfolios for more consistent returns.