Baron Forex News

By Liz Capo McCormick and Matthew Brown – Sep 1, 2010 12:27 PM

Investors who follow trends are reaping the biggest gains in the foreign-exchange market this year as a 11 percent slide in the euro and the surge in the yen against the dollar provide the most profitable returns.

Royal Bank of Scotland Group Plc indexes that track the performance of four of the most popular currency strategies show that the so-called trend style was the best-performing method, returning 7.3 percent this year through August. The biggest loser was the volatility strategy, which is down 5.9 percent.

Foreign-exchange trading rose to $4 trillion a day on average even as growth in the market slowed in the three years through April, a Bank for International Settlements survey released today showed. Trading increased 20 percent, down from a 72 percent pace in the three years to 2007, the BIS said.

“Trend-following investors are capturing the momentum in several big currency moves,” said Dick Pfister, head of global sales and consulting at Altegris Investments in La Jolla, California. “You have so much uncertainty in the world now with regard to inflation or deflation, which typically makes currency markets and interest rates move. That is good for trend followers as it causes volatility, which typically creates good profits.”

Volatility Strategy

The yen rose as high as 83.60 per dollar on Aug. 24, the strongest level since June 1995, and traded down 0.3 percent to 84.48 today. The euro reached a four-year low of $1.1877 on June 7, a 17 percent slide versus the dollar from the end of last year. The 16-nation currency rebounded amid optimism following a European Union-led 750 billion-euro ($996 billion) regional aid package and a strengthening German economy. The currency strengthened 1 percent to $1.2805 at 12:24 p.m. in New York.

The volatility strategy, which makes money as rapid movements in currencies diminish, may remain a laggard with currency swings not expected to dwindle anytime soon, according to strategists at JPMorgan Chase & Co.

Foreign-exchange volatility will stay high this year, even as the Federal Reserve is expected to keep its benchmark interest rate locked in a record low range of zero to 0.25 percent range, according to JPMorgan.

Implied volatility on options for major exchange rates averaged 12.6 percent over the last year, compared with an average of 10.5 percent back through January 2000, according JPMorgan data. The bank’s index of three-month options should range between 12 percent and 16 percent in the current period of slow global growth and potential deflation, said John Normand, head of global-currency strategy at JPMorgan in London.

Shorter Trends

“Synchronized G-3 deflation would create credit stresses, which prompt spikes in foreign-exchange volatility,” said Normand, referring to the economies of U.S., Japan and the European Union. “Potential for currency volatility spikes rises the longer a weak-growth/low inflation backdrop persists.”

The carry style of investing, where traders borrow in lower yields currencies and invest in countries with higher returning assets, has lost 4.4 percent this year. The valuation style of investing has returned 4.5 percent, according to RBS.

Currency strategists and so-called quantitative analysts are trying to develop models that work even when trending periods are shorter amid volatile markets, which can whipsaw exchange rates and hurt trading profits.

David Woo, who joined Bank of American Corp. last month from Barclays Plc as head of global interest-rate and currencies research at its Bank of America Merrill Lynch Global Research unit, said he’s developing models to catch trends early and signal when to get out before they fade.

“There are still trends, but they don’t last very long,” said Woo, who is based in New York. “A lot of people are really scratching their heads. Making money in this new trading environment is the biggest challenge for people today.”

To contact the reporters on this story: Liz Capo McCormick in New York at Emccormick7@bloomberg.net; Matthew Brown in London at mbrown42@bloomberg.net