In my first post ever, I wanted to share some knowledge I've gained while working at a hedge fund in the past year or so. I've learned so much about daytrading from you guys, that I wanted to give something back to the community.
I'm only sharing this with you because I've had to move from NYC and this pretty much means I'll be out of the investment management business in the short to medium term.
First of all, they are looking for at least four main signals to fill whenever building a strategy within a specific asset class: value, momentum, yield and growth.
For instance, suppose I wanted to create a stock-selection model.
Then I would probably select P/E as my value factor, 12M-1M momentum as the momentum factor, dividend yield as my yield factor and ROE as the growth factor. I would gather all the data from stocks in my selection space, sort them by each of the factor, sum the ranking for each factor for every stock then re-rank the stocks according to the final ranking.
Then I would buy the top 10 percentile and short (or not, especially in stocks) the bottom 10 percentile.
Now what about FX?
Well, it's the same thing. Assume all currencies are being measured against the USD. Hypothetically, one could use the following factors:
Value: Real Effective Exchange Rate
Momentum: 6M Real Gains from the Forward (you have to remove carry from the momentum factor)
Yield: Carry (Interest Rate of Selected Country - Interest Rate of United States)
Growth: Equity Market Momentum (12M-1M momentum)
You can then go through the same process of building the ranking for each currency against the US. Then you select the top 30% currencies and go long, and the bottom 30% currencies to go short, for instance.
Then you can just trade the pairs you are interested. For instance, if the model tells you the following currencies are what you want to trade against the USD:
Long - BRL, SGD, NOK
Short - AUD, CAD, CHF
This means that you want to go long BRL/AUD or SGD/AUD or NOK/AUD and so on.
Here are the hypothetical results of a model just like the one I showed you, using G10 currencies for the past 20 years:
How would I use this as a short-term trader? By looking at the currencies that are in the top/bottom percentile, you know where the funds are focusing, and thus, where the OTF participant may come in to move the market.
I hope this sheds some light into what professional hedge fund managers are doing.
Cheers,
squ1d
P.S. If you'd like to know anything else, let me know. I'll also build a model with freely available data and keep it up-to-date here - I just need to find a way to automate the data gathering, since I don't have Bloomberg/FactSet anymore.