RDP 2004-07: The Profitability of Speculators in Currency Futures Markets 5. Conclusions

Using data on the net positions of speculators in six currency futures contracts on the CME we have provided evidence that speculators appear to be profitable, even after adjusting for transaction costs. Accounting for reasonable estimates of transaction costs, speculators seemingly make total profits of around US$10 million per week.

Because of the volatility in futures prices, speculator profitability is far from consistent, with the median proportion of profitable weeks in a single currency just 0.53. But by diversifying across currencies the proportion of profitable weeks jumps to 0.60. The fact that a group of traders can seemingly make statistically significant profits at all from trading currency futures is remarkable and suggests that specialist traders do have some ability to predict changes in exchange rates and currency futures price.

We considered two explanations of why speculators could profit at the expense of other market participants. The correlation of speculators' positions with ex ante expected returns suggests that profits could be a premium for bearing idiosyncratic risk, that is a reward for taking a position that otherwise they would not have taken.

This is supported by the finding that most of speculators' profits appear to be predictable. An alternative interpretation of this result is that speculators use more accurate forecasting techniques. Some evidence for this is found in the correlation of speculator positions with past futures returns. Given the well-documented use of trend-following trading rules for short-run expectations formation in exchange rate markets it appears that speculators may be using such rules. Trading rules have been shown to be able to make hypothetical profits, though studies are subject to the criticism that rules are selected ex post. Our results present additional evidence that these rules are profitable. Unfortunately it is not possible to conclusively distinguish between these competing explanations. Speculators may be more accurate at forecasting the exchange rate. But it is also possible that the two groups are equally accurate in forecasting but hedgers knowingly trade at less favourable prices in order to induce speculators to hold the offsetting position. The evidence suggests that, in all likelihood, both explanations contribute some portion of speculator profits.