A momentum trade is a trading strategy where a trader buys currencies with high past excess returns (”winners”) and sells in currencies with low past excess returns (”losers”).
The idea is to go long in a portfolio of “winner” currencies and go short in a portfolio of “loser” currencies.
It all depends on their short-term behavior in the immediate past.
One distinguishing feature of the momentum strategy is that the long-short combination requires more frequent rebalancing than the Carry Trade strategy which results in a less stable currency composition over time.
As a result, transaction costs are potentially large.
By design, momentum strategies may potentially perpetuate past directional moves in exchange rates.
This could result in amplification, as well as delayed, but more abrupt exchange rate moves.
Momentum strategies are also known as “trend-following” strategies.
They have been quite profitable across several asset classes, including equities, commodities, and corporate bonds.