What works better for currency trading, technical or fundamental analysis? In their April 2013 working paper entitled “Exchange Rate Expectations of Chartists and Fundamentalists”, Christian Dick and Lukas Menkhoff compare the behavior and performance of technical analysts (chartists) and fundamental analysts (fundamentalists) based on monthly surveys of several hundred German professional dollar-euro exchange rate forecasters, in combination with respondent self-assessments regarding emphasis on technical and fundamental analysis. Forecasts are directional only (whether the dollar will depreciate, stay the same or appreciate versus the euro) at a six-month horizon. The authors examine three self-assessments (from 2004, 2007 and 2011) to classify forecasters as chartists (at least 40% weight to technical analysis), fundamentalists (at least 80% weight to fundamental analysis) or intermediates. Using responses from 396 survey respondents encompassing 33,861 monthly time-stamped forecasts and contemporaneous dollar-euro exchange rate data during January 1999 through September 2011 (153 months), they find that:
- On average, respondents assign about 60% weight to fundamental analysis and less than 30% weight to technical analysis (with the balance to order flow analysis).
- These weights are fairly persistent over time, but respondents tend somewhat toward (away from) technical analysis when the exchange rate trends (deviates strongly from its long-term average).
- Chartists lean more toward trend-following than fundamentalists, with strong trends required to attract the attention of the latter. Accordingly, fundamentalists rely slightly more on mean reversion than chartists (when the exchange rate deviates strongly from purchasing power parity).
- Chartists tend to revise the direction of their forecasts more frequently than fundamentalists.
- Translating individual forecasts into trading strategies:
- At the specified six-month forecast horizon, neither chartists nor fundamentalists achieve an impressive average annualized gross Sharpe ratio. Results do not support belief that either chartists or fundamentalists on average produce profitable advice on a net basis.
- At the specified six-month forecast horizon (and other horizons as short as two months), average gross returns from trading on chartist and fundamentalist forecasts are about equal.
- However, at a one-month horizon, the average gross return from trading on chartist forecasts is higher than that from trading on fundamentalist forecasts.
In summary, evidence suggests a potential gross edge from technical analysis (trend-following) for short-term dollar-euro exchange rate speculation.
Cautions regarding findings include:
- As noted by the authors:
- The forecasters are not themselves traders, and people may behave differently when consequences are directly monetary rather than largely hypothetical.
- Actual behaviors of individual forecasters are more complex than suggested by the simple definitions of chartists and fundamentalists.
- Since the translation of forecasts into trades does not account for trading frictions, the short-horizon edge for chartists over fundamentalists may not hold on a net basis (since chartists change forecast direction more frequently).
This research has some parallels with “Guru Grades”.
