If you watch a lot of business news on cable, you will inevitably see advertisements for software platforms that enable do-it-yourself currency trading.
Great fortunes have been made by traders who correctly predicted swings in the dollar, yen or pound, that much is true.
But winning big in currencies is harder than it looks — even if you happen to be one of history’s greatest economic thinkers.
That’s the conclusion two scholars reached after scouring the records of John Maynard Keynes, the British economist who, when he wasn’t advancing economic thought in the 1920s and 1930s, spent a great deal of time investing in stocks and currencies. At the peak in 1936, Keynes had more than 250,000 pounds invested, the equivalent of $23 million today.
But even while writing a treatise that would be one of the foundational texts of 20th-century economics (“The General Theory of Employment, Interest and Money,” published in 1936) and hobnobbing at the highest levels of global finance, his returns were pretty, well, mediocre. He had an average annual return of 8.9 percent from 1920 to 1927, and a mere 2.5 percent from 1932 to 1939, according to research by Olivier Accominotti of the London School of Economics and David Chambers of the Cambridge Judge Business School newly published in The Journal of Economic History.
Those gains look particularly modest given the risks Keynes was taking on, as he experienced huge swings in his portfolio when his bets turned out wrong. And simplistic trading strategies relying on the momentum of currencies and the “carry trade,” of borrowing money in a currency with low interest rates and investing it in a currency with a higher rate, outperformed his more judgment-driven choices, at least during the 1920s.
Keynes bet that the United States dollar would appreciate — just before Franklin Delano Roosevelt abandoned the gold standard in 1933, a move that caused the dollar to lose value. Keynes did correctly predict that France and the Netherlands would eventually abandon the gold standard in the 1930s, leading to declines in the franc and guilder. But he was early, and so incurred years of losses on the trade before his economic foresight paid off.
“In many cases he called currencies right in terms of direction,” Mr. Chambers said. “But his great frustration was how to time a trading position. That was the thing he found most difficult.”
Are there any lessons to be had from the trading records of a man who died 70 years ago? Just maybe.
The first is the simplest: In financial markets, being brilliant isn’t enough. The best traders have to not only understand the fundamentals of the asset they are trading, but also have almost a sixth sense for how the timing and momentum within markets will evolve. You can lose a lot of money having the right idea at the wrong time.
The second is that even skilled traders may need to be willing to incur major losses — which explains why hedge funds that face redemption requests from investors can face major problems even when their underlying investment thesis is right. “The Big Short,” the book and newly released movie, captures this nicely when a hedge fund manager who correctly bet against mortgage-related securities faced angry investors who sought to withdraw money while waiting to be vindicated.
“Keynes’s experience shows how difficult currency speculation is,” Mr. Chambers said. “He was trading his own money and he understood what he was doing. He was able to absorb losses. Some hedge funds are trying to do this stuff and live hand-to-mouth on a quarter-to-quarter basis, and that’s really difficult to do.”
Keynes was also an active investor in the stock market, and in the 1920s tried to time stock picks. But his returns were low, and he took a big hit in the market crash of 1929.
In the 1930s, he shifted toward a long-term approach of buying stocks with good long-term potential and holding them indefinitely, what Mr. Chambers calls “essentially a Warren Buffett type of approach.” His returns improved.
So the final lesson on money management from the trading records of one of the 20th century’s great economic minds may be the most fundamental of them all: The person on the other side of the trade probably knows more than you.
