Currency Cross Backtests and Base-Currency Profit Measurement

Summary

The document asks how a USD-based backtest should account for a trade in a currency cross, using EUR/GBP as its example. One proposed approach explicitly converts USD into the currencies needed to enter and exit the position; the other tracks the cross’s performance and converts the result to USD at exit. The concern is that currency movements during the conversion legs could affect measured performance independently of the cross signal.

The answer notes that cross exposure may commonly be implemented through futures or forwards, where the trader funds margin rather than converting the full notional between currencies. It recommends calculating daily profit and loss in the chosen base currency, while allowing multiple currency balances to be held and converted periodically. The response is brief and gives no contract-level accounting example or comparison of the two backtest methods, so instrument, funding, and broker details may affect implementation.

Key ideas

• A backtest should distinguish the performance of the currency cross from the effect of converting cash to enter and exit.
• Futures and forwards may provide cross exposure without converting the full trade notional.
• Daily profit and loss should be measured in the portfolio’s base currency.
• Currency balances can be held separately and converted to the base currency periodically.

Tags

# modelling FX with crosses: USD conversion on entry and exit, or just exit?


# modelling FX with crosses: USD conversion on entry and exit, or just exit?












I am backtesting a model that trades currency crosses (i.e. EurGbp) at a fixed $1 mln per trade and was curious if I need to a) account for my currency exposure to GBP on both ends of the trade or b) only upon exit?

for example with a long EurGbp Signal:

a) Use $1 mln USD to buy GBP which I then sell in order to Buy EUR, then upon signal to exit the trade, sell the EUR and purchase USD

b) simply track the EurGbp trade performance then convert back to USD on trade exit

Option a is clearly more realistic in terms of trading; however, the 'pure' model signal is to some extent distorted by the currency risk taken to leg into and out of the FX cross.

Any insights are much appreciated!

## Answer by user42108 (score 2, accepted)

https://quant.stackexchange.com/a/59375

Firstly, it's highly likely you would be trading either futures or forwards so your only concern is funding your margin at your FCM/PB (e.g. see CME) Why you would convert USD to EUR, I dk.

Secondly, you should be calculating your PNL at EOD back to your 'base' currency (which seems to be USD from your post).

Related to the above, it's common simply to hold balances in a number of currencies at your FCM/PB and periodically convert to your 'base' currency, e.g. at quarter-end, independently of your daily PNL calculations.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.