No time for losers

Whenever I emerge from South Kensington station in London, a sense of happiness envelopes me. It isn't because the women are slightly more beautiful there, indeed, I once spotted Liz Hurley in the streets of South Ken. It isn't because the cars are that bit shinier and more Italian (Ferraris) than elsewhere in London. Instead, it is because of the memories the area conjures up in my mind, reminding me of my university days at Imperial College, a time when hair used to be welcome on my head. Several years ago, I made this pilgrimage back to South Kensington and Imperial College across from the City, where I worked at a little place called Lehman Brothers, to see an Imperial alumni lecture.

The lecturer was Brian May or I should say Dr. Brian May, also known as the guitarist in Queen. His lecture dwelt upon physics and in particular the subject of his PhD in the field of astronomy. I was constantly expecting him to discover a guitar from beneath the stage for an impromptu concert playing the chords to We Are The Champions, before the audience would begin to revel in the refrain (the lyrics of which, I have partially written below). According to the lyrics, for champions, there is "no time for losers".

We are the champions.
No time for losers
'Cause we are the champions of the world.

When it comes to trading I would disagree with that notion. Every successful trader is never continually a champion. Instead a trader, needs to navigate that route between perpetual loserdom (a word which I suspect I have made up) and championdom (another word for which there is no dictionary entry). After all, to make gains trading, a trader needs to battle through losing trades to get there. Where a trade has virtually no losing trades, it suggests that their strategy relies upon ideas such as heavily leveraged option selling. Either that or the capacity of the strategy is severely constrained. Indeed, a very high Sharpe ratio might seem welcome, but it does not tell a trader whether the strategy itself is unstable and prone to sudden breakage, either through a drawdown or simply the permanent breakdown of the strategy.

Approaching the subject from a systematic trading perspective, we can usually compare losses with our historical backtest. If they seem in line with historical losses, it gives us some comfort that the losses we have observe are not unusual. Alternatively, if they are blown out of all proportion to historical losses, it can be an indication that something more is afoot. Of course, one thing we cannot backtest is pain (from personal experience!) In any case, whether we are discretionary or systematic traders, we should know how to react to losses, above a certain level.

Losses are never pleasant in trading, but they cannot be avoided. The key is understanding why they have happened and to learn from them. So for traders, there has to be time for losers to somewhat paraphrase Queen.

My book Trading Thalesians also has some colour on this topic of examining historical returns and also understanding the risk of trading strategies (mixed in with a bit of ancient history).

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Fruity carry filtering

Later, I am due to attend George Cooper's Thalesians talk in Budapest on his new book Money, Blood & Revolution. In the meantime, I am supposed to while away the hours. I should be adept at doing very little. Unfortunately, whiling away hours is something which I am ill suited to. I always have to be thinking or writing or analysing. Perhaps, an inability to do nothing, suggests a long holiday is necessary soon. Maybe it is the human condition to desire peace, but once peace comes to desire work or maybe it is just me?

In an event to soak up these free hours, I am sitting in Budapest's central market hall (Nagy Vasarcsarnok) which is punctuated by many various stalls and is pictured above. My eyes intermittently rest on this iPhone's screen, in between brief seconds when they glance at the market, my fingers tapping away these words. Around me some stalls specialise in Hungarian pastries, such as retes, a type of strudel, which I advise sampling. Other stalls are butchers, whilst much of the rest are green grocers, displaying all manner of fruits and vegetables. Whilst some of these stores are nearly identical to their neighbours, somethings are certainly different: the number of customers they are serving.

Some of the shopkeepers seem to be staring into the distance, somehow hoping for a customer to drift past and show interest. Other stalls seem persistently busy, with customers continaully swarming their stalls. When the foot flow picks up, all the stalls seem busier. I imagine towards the end of the day, there will so little footflow, even the busier stalls will become quiet.

In a sense, this market is not very different to financial markets. We have sellers (the stalls) and we have buyers (the customers). When markets are buoyant, investors are less discriminatory. They simply want to hunt for yield. At present, we are in the situation where there is large foot flow nearby all the stalls selling "high yield". Indeed on finance based Twitter a lot of commentary has been dedicated to this topic (in somewhat tongue in cheek fashion).

Whatever has yield, regardless of the fundamental story seems to be bid. To some extent we see this today, where all sorts of names are issuing debt. The challenge is not to know who has raised debt, rather it is to know who hasn't been raising debt!

The question is of course, how long will this last? I would love to give you a perfect prediction! From a quant point of view this notion of being able time "risk" trades is something that all of us wish to do. In FX, this amounts to trying to model FX carry returns. We want to predict when the music will stop playing to somewhat paraphrase Chuck Prince (NYTimes: Citi Chief on Buyouts: ‘We’re Still Dancing’ 10 Jul 2007). When will all the carry stalls be "popular" and conversely when will they not? Some solutions are less satisfactory than others.

The idea that we can develop a perfect filter which avoids FX carry drawdowns during periods of poor risk appetite, seems too good to be true. I would argue that it is! Yet, that does not mean we cannot mitigate the impact of drawdowns via a carry filter and have something less than perfect.

I would argue that the key problem with risk filters is how they are implemented, rather than the concept of using a filter. If your filter has too many false signals it will perversely make you end up worse off than running no filter at all. You can end up being caught on the wrong side of risk sentiment repeatedly with a poorly designed filter. Furthermore, how should the filter actually be traded? Should a carry filter be a simply on/off switch? Or should it be more progressive?

Just because we cannot predict Black Swan events, it does not mean we throw up our hands and do absolutely nothing to at least try to reduce their fallout when they do indeed happen. In the case of FX carry and indeed many high beta exposure, a risk filter can help to reduce (but not eliminate) drawdowns. Just make sure you design it carefully and are able to avoid some of the pitfalls associated with risk filters, which I have discussed.

Perfection is impossible in any market, but less than perfect can just about be good enough in trading.

This was written before George's Budapest talk at the Thalesians, which took place on Friday 25th July. I shall be writing a bit more about his talk and book soon on the blog!

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Why trade?

If we go back to the ancient world, let us think of Thales of Miletus, the ancient Greek philosopher. He was mocked for being a philosopher, who couldn't make money. To prove his doubters wrong, he bought options for the use of olive presses, during the low season, because he foresaw a great harvest. When it was indeed a great harvest, Aristotle tells us, he made a fortune. An illustration that sometimes, you can make money as a by product of other objectives (in Thales' case merely to disprove his doubters). Our group the Thalesians is named after Thales. It was this story about olives, which gave me the idea for my book Trading Thalesians.

If we think more broadly about the title of this article, it might seem like a ridiculous question: why trade? The answer might seem obvious and consists of one word: money. However, there are a multitude of ways a trader can make money, which can impact whether we are successful. If a trader simply wants to maximise his or her returns in isolation, then perversely the result, could actually be lower returns. Conversely, maybe the better approach is to target some other factor, just like Thales did, in his olive trade?

Why? If your sole objective is maximising returns, it is very tempting to over-leverage and to take on too much risk. The result is of course, an inability to tolerate any sort of drawdowns. Even what might have been a relatively small drawdown on an unleveraged basis, might force a highly leveraged investor to exit all risk. Hence, a trader will have taken losses, but unfortunately not the profits of a strategy.

If instead, an investors targets lower vol (so lower leverage) and lower drawdowns, potentially in the long run, returns might be more sustainable. In this instance, an investor is more able to hold onto their positions and continually generate returns.

We might not all be like Thales, but we can try to learn from him and the ancient world!

My book Trading Thalesians: What the ancient world can teach us about trading today also has some colour on this topic (mixed in with a bit of ancient history).

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What's gamma trading?

Given this blog is supposed to be interactive, I asked my readers for ideas for this article. By popular demand (well at least 3 readers @krs, @JeremyWS and @jaredwoodard), it was suggested that I write an article explaining what gamma trading is.

Let's first consider the simplest option trade we can do to get exposure to short volatility. We could sell a straddle (so basically a call and a put) in this instance. If spot stays close to the strike, we would make money at expiry, as we would pick up the option premium (and the payoff would be close to flat). However, in the event of a large directional move, the trade would result in a large loss. We could of course delta hedge our exposure and run a delta neutral position. If we are short vol, this would involve buying spot as spot rises and conversely selling spot as it falls. The conundrum is obviously how frequently we delta hedge (see my paper for backtested results on this!) Clearly, continuous delta hedging is not possible (and would be too costly in terms of transaction costs).

If we think about how we can calculate the P&L from a delta hedged short vol position, we need to mark to market the option and also calculate the P&L on the various spot trades which have been undertaken for delta hedging. However, what we want is some more intuitive way to relate this P&L to implied and realised volatility.

It can be shown that our P&L can roughly be expressed as a gamma weighted difference between implied and realised variance (assuming we don't have large exposure to other greeks and that we have short vol exposure). This equation is given below. Sorry, the quant part of me loves formulae - skip it if you find mathematics offensive! Note, that the formula is different to a variance swap, which obviously doesn't have the gamma term.

Looking at the formula, it is not surprising that trading options in this way and delta hedging is known as gamma trading. Shorter dated options have more gamma and also when spot is trading closer to the strike, gamma will be higher. Hence, if we are short gamma and very close to expiry, with spot oscillating rapidly around the strike, we could be faced with large losses (if we take a look at the formula). Conversely, if realised vol picks up and we are short gamma, but spot is very far from the strike, P&L is not impacted as much.

On the plot at the start of the blog, we have plotted the returns for being short EUR/USD vol (short-dated straddles) splitting up the returns into option P&L and delta hedging P&L (but excluding transaction costs). We can see that in 2008, whilst our option had a drawdown, our spot delta hedges made money, illustrating our earlier point that delta hedges can offset the losses from large directional spot moves.

We note that short gamma is generally profitable as a strategy in the plot (and actually more broadly). This is because of the volatility risk premium. This simply describes the fact that implied is generally above realised volatility. So by selling volatility we are harvesting this risk premium. Obviously, there are drawdowns associated with capturing risk premium in this way, as we have mentioned.

In this very short summary, we have very briefly described gamma trading and related it to the differential between implied and realised volatility, using a simple formula. Please also see my interview at Global Derivatives by Robert Almgren where I describe systematic gamma trading in FX.

To read more about this topic please see the below work I've done, which goes through the subject in much more detail, including systematic strategies for trading gamma in FX (and discussing optimal ways for delta hedging). My book Trading Thalesians also has some colour on this topic (mixed in with a bit of ancient history).

Thalesians - Gamma, gamma, gamma - Explaining gamma trading in FX markets - 14 Apr 2014 (available for Thalesians clients only)

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Traders matter more than their code

I really love Twitter. Yes, I've said it. True, it seems to absorb time, like a never ending sponge. However, on the plus side I have learnt a huge amount about finance by using Twitter. Recently, I started following @krscapital and I recommend you follow him too, if you're a finance Twitterer. He recently tweeted a link to an article entitled Wall Street Techs Take Secrets to Next Job at Their Peril (on Bloomberg) alongside the following quotation taken from the same piece: "strategies that were once in a trader’s head have taken physical form as stored code"

Rather than attempting to fully discuss the piece, I instead wish to focus more on the quotation above. The gist of the quotation is seems to be the that code can replicate a trader's brain. To some extent that is true. Within code, we can create a model which trades on the behalf of a trader. Simply flick a switch and it starts trading all by itself and the money comes in. However, is it that simple? No.

Who decides how much capital to place on a trading model? The trader of course. Hence, the code does not totally remove a trader from the business of trading. It is simply, that he or she, has a slightly different role to play. Hence, a trader still has considerable responsibility.

Yes, the code which encapsulates a model is important. This is particularly true, when it comes to very high frequency trading. In this instance, the speed of the code becomes a crucial factor in its success. However, if we think more broadly, far more important is the trader who actually builds, understands and continually hones a trading model. Without a deep understanding of a model, it becomes impossible for a trader to have the confidence to place risk on it.

The value of traders is not what they have achieved already, but what they will develop in the future. A trader who builds a single model in his (or her) whole career and then keeps it like a museum piece, by contrast seems less valuable. After all, trading models generally don't work "forever", particularly those which are more "alpha" in their approach, which have higher risk adjusted returns.

If models did last "forever", maybe, just maybe, a piece of code could be more valuable than a trader. Code is a tool for a trader to make money. By contrast, code without a trader holds far less value. Furthermore, the notion that there is some "secret sauce" a special code for successful trading seems pretty unlikely in my view and having talked with many systematic traders over my career. If anything, I suspect the notion of a "secret sauce" is more marketing exercise than anything else.

To read more about this topic please see my book Trading Thalesians which has a chapter on the notion of whether there is a "secret sauce" to trading (mixed in with a bit of ancient history).

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The time when Iraq invented time

For today's post something a bit different to my usual quant posts in this blog. So feel free to skip if you prefer my quant articles!

Humanity revels in the beauty of the future, seeking to make the unknown known. In 2003, Bush and Blair said Iraq’s future would be bathed in beauty. However, in modern Iraq, the future has rarely turned out to be quite so beautiful. So often in modern Iraq, the future’s only consolation is that it signals the end of a tumultuous today. However, Iraq’s present is not the subject of this column. We can see the present Iraq every time we read a newspaper. It is not for me to add to the large stream of opinions on the current situation: I am simply a writer, with no specific insight into the Iraq of today, save for my heritage. I have not suffered under the yoke of war and dictatorship in Iraq, which have been an ever present feature of Iraq’s living memory. I shall leave that to others, most notably, the people of Iraq, to be the judges of the present and the creators of tomorrow.

Neither do I want to look into the future. Instead, I seek to understand the past, before the invasion of Iraq. It is Herodotus, the father of history and author of “The Histories”, who reminds us that the benefits of seeking knowledge of the past, is in itself not sufficient. It is the understanding of why events occurred which is far more important.

When I refer to the past in this article, I do not mean the brutality of Saddam nor do I mean the creation of modern Iraq by the British. The past I write of, is the time when Iraq invented time. Humanity split an hour into 60 minutes and a minute into 60 seconds because of the ancient Babylonians. Their ancient city lies as ruins today, several miles from the city of Hilla, where my late father grew up in the fifties. Babylon’s proximity to Hilla is confirmed by several grainy black and white pictures I have. They show my father surrounded by his friends, his age perhaps not even in double figures sitting atop of Babylon’s ruins.

The modern age has seen tremendous progress in many different fields with the rapidly increasing pace of technological change. Despite this, it is sometimes the case that the ancients can still inform us about today. Of course, the ancient world was hardly perfect. It was brutal and in many obvious ways, it was a less pleasant place than today. However, it was also a time when man began to create civilisation. In ancient Babylon, it is Hammurabi (1792 BC – 1750 BC) who reminds us of this. Other kings of Babylon were known primarily for their military conquests. Hammurabi was known for something quite different. He called himself the king of justice, a title for which he is remembered today. The proof of this lies in the Lourve. There you will find an igneous rock fashioned into a stele, resembling a fingertip, nearly 2.25 metres tall and 0.65 metres across. It is known as the Code of Hammurabi. Carved into it, in cuneiform script, are nearly 300 laws (although the precise number is unknown). Cuneiform script originated from the Sumerians well before Hammurabi’s time and was the first example of writing. Another example of how Iraq’s past fashioned civilisation into today’s modern world.

Mieroop (King Hammurabi of Babylon 2004) describes perhaps the most famous law of all, which describes the concept of a tooth for a tooth, eye for an eye, a concept that is also in various religious texts. There are other laws in the code which describe ideas such as insurance. There is a specific example which explains a form of insurance designed to reduce the risks which traders faced carrying goods across the desert. Maybe today, we should consider ways we can better manage the risks we take in whatever decisions we take. Closer to my world, of financial markets, it seems obviously that the root of many market crises is excessive risk taking. This is as true of today’s markets, as it was in ancient times.

So today, when you hear of the violence in Iraq, pause for a moment. Remember that Iraq gave time, law and the written word, a small selection of the many gifts it has bestowed to humanity. Even if today it might seem unlikely, in the future, Iraq will have its time once again in peace. Perhaps, Iraq really will be able to revel in the beauty of its future.

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Fixing the 4pm fix

There has been a considerable amount of controversy around the 4pm FX fix. It has been a big media story. We can see in the chart above, the number of articles on Bloomberg News referring to WMR. From the chart, last summer was the starting point for much of this media coverage. Earlier this year, I published a Thalesians paper discussing the 4pm fix (link: Thalesians: Taking on risk at 4pm - Estimating cost of 4pm fix for market makers 11 Mar 2014), which was featured in the WSJ (link: WSJ: Why FX Traders Trade: A Reminder 11 Mar 2014). In particular, I attempted to quantify the risk which market makers face around the 4pm FX fix, by modelling intraday option prices and also understanding intraday volatility around 4pm.

Today, the Financial Stability Board (FSB) published their comprehensive report on foreign exchange benchmarks after a long investigation. Katie Martin's WSJ recent article (link WSJ: Basel’s Super-Regulator On FX Benchmarks (And Traders) 15 Jul 2014), offers a concise summary of the FSB's findings, which I recommend reading. Martin notes several points from the report, which I have listed below.

• The benchmark does not need to be changed significantly, which somewhat differs from the situation we had with LIBOR. 
• Banks should ensure that guidelines are followed around the fix (eg "address potential conflicts of interest arising from managing customer flow")

If we delve into the FSB's report there were several other interesting points, which tally with a lot of the findings from my paper. The FSB notes that the FX market maker faces a risk when offering to guarantee an unknown price (ie. 4pm fix) to a client. In my paper, as mentioned I attempted to quantify this risk, by modelling intraday options.

"FSB: It also creates a market where the dealer is agreeing ahead of the fixing time to execute 
at an unknown price, which is established subsequently during the fixing window as the 
clearing price which reflects the balance of those fixing transactions and other transactions 
undertaken in the calculation window. In many cases, the dealer agrees to give the client the 
mid-rate of this (as yet unknown) fix price, rather than applying a spread, whether they are 
buying or selling. Given the market structure, the dealers can be placed under strong pressure 
to try and offset the risks they face given the price commitment."

The FSB's report also presents some interesting quant results. The FSB notes that whilst FX volume is higher around the fix, as we might expect, the pick up in EUR/USD volatility is less than it is at other times of day (such as US data releases), which tallies with my earlier report (chart below). In my report I also analysed intraday volatility for other currency pairs too.

As well as making recommendations for the sell side, the FSB also make several key suggestions for asset managers. In effect, they suggest that asset managers should address their own FX execution and do their own research around the topic. This, I think, is crucial. Whenever, I have worked on FX systematic trading strategies, understanding transaction costs has been crucial and a considerable amount of my time has been spent understanding how they impact overall returns. Transaction costs are not just incorporated in the bid/ask spread, but also include slippage in execution. Obviously, I am talking my own book here, as we say in the industry, given I offer quant analysis services to clients (including transaction cost analysis). However, it does seem reasonable to expect that if investors choose not to research their own FX execution, then it is likely they will end up paying a lot more later through suboptimal execution later.

"FSB: The group recommends that asset managers, including those passively tracking an index, should conduct appropriate due diligence around their foreign exchange execution and be able to demonstrate that to their own clients if requested. Asset managers should also reflect the importance of selecting a reference rate that is consistent with the relevant use of that rate as they conduct such due diligence."

Whilst I still haven't read the FSB report yet in its entirety, what I have read so far is well worth a read. It also seems to be well balanced, acknowledging the risks which market makers face when offering the fix, which seems to have been lost in a lot of the media coverage. At the same time, it makes suggestions on how banks could better manage the execution of the fix.

Please also take the time to read my paper on 4pm FX from earlier this year.

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Much ado about low vol

The notion of nothing is one thing that the market loves to talk about at present, . I mean nothing in the sense of there being low vol. By which ever metric you choose, implied vol seems low. VIX is sheltering in the 10 area, whilst in FX, EUR/USD 1M implied vol is on a 4 handle, spurred by central banks which have presided over a period of easy monetary policy.

If vol is so low and is intrinsically mean-reverting, we might expect vol to rise. The problem is of course that the precise timing is tricky, which requires a trigger. In terms of "known" triggers, one of the most likely candidates for this are Fed hikes (I won't pretend that I can guess the "unknown" triggers. The difficulty with long vol trades is that they are negative carry. Hence, if your timing is wrong, you could well bleed for an extended period of time, which could well outweigh gains you make when the market eventually goes bananas. After all, we can remain in an extended period of depressed or falling vol. Simply look at how vol has behaved over the past few years.

The key point however, is that it is not just implied vol, that impacts P&L of a gamma trader. In particular, we need to recall that for a gamma trader, what is most important, is not simply where implied is, but the differential between realised and implied (strictly speaking if we are trading gamma through vanillas and delta hedging this difference is gamma weighted). This differential is the volatility risk premium. Indeed, this point was made by Matt Levine recently on Bloomberg View, where he discussed it from a VIX angle. Typically, the volatility risk premium is positive, given that implied tends to be above realised. After all, traders selling vol need to be rewarded for selling insurance. In the plot above, we have shown EUR/USD 1W implied - realised volatility, to illustrate this point.

Obviously, the issue with being short gamma is that if realised vol blows up above implied, you are faced with a nasty drawdown. We can to some extent mitigate this drawdown, by delta hedging (as opposed to nakedly selling straddles). If realised manages to remain relatively well behaved, we should still make money regardless of where implied goes. If anything, when the volatility risk premium blows up, it gives us a chance to harvest additional premium from being short gamma.

So next time we hear about vol being depressed, I'll be taking a look not just at implied but also how it is trading versus realised. Just as drawdowns are the drawbacks for short gamma trades, so the gradual bleed can impact long gamma trades.

To read more about this topic please see the below work I've done, which goes through the subject in more detail, including systematic strategies for trading gamma in FX. My book Trading Thalesians also has a chapter on measuring risk (mixed in with a bit of ancient history).

Thalesians - Gamma, gamma, gamma - Explaining gamma trading in FX markets- 14 Apr 2014 (available for Thalesians clients only)

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What can traders learn from Brazil's defeat?

The World Cup has unsurprisingly spurred much media coverage (see above) as the world has been glued to the spectacle for the past few weeks. Brazil's defeat at the hands of Germany by 7-1, has prompted many questions. Absent from Brazil's team were Thiago Silva and Neymar. Whilst I am not a football pundit, it seems difficult not to attribute part of Brazil's loss to their absence. In a sense the team was centred around Neymar and without him (and also the usual captain), Brazilian goals were hard to come by and worse, the team lacked cohesion. Simply contrast that to Germany's performance, which really was a team effort.

There have been numerous articles on how Brazil's performance at the World Cup could impact Brazil's markets and more broadly even its politics (wonder what the odds are of Dilma winning now?). Before the World Cup, I wrote a Thalesians piece examining the relationship between vol markets and the tournament.

However, from a trading point a view, I believe there is something more fundamental which traders can learn from the defeat: diversification. Brazil had too many eggs placed in the Neymar basket. There was no diversification, just like a portfolio which has its risk concentrated in one position. This might well work, if your number one asset where you have all your risk is performing. However, it fails miserably, in all other cases. This is particularly the case if you are leveraged, where drawdowns can force you to exit a position sooner than you might want to do so. The idea of diversification is just like that of a team: together the portfolio should have better risk adjusted returns. Furthermore, when it does all go wrong, diversification is designed to make a bad situation at least bearable (admittedly easier said than done).

Whenever constructing a portfolio, we need to be aware of where the possible losses could come from and be prepared to mentally assign probabilities to them. If the probability assigned to a catastrophic event which could negative impact your portfolio is very high, is it really diversified? Are there hedges we could employ to reduce the risk or should we simply cut our leverage so that the risks are manageable (yes, simply cutting you risk can sometimes be an alternative to a hedge!). Just like a football team relying on its start striker, a trader cannot simply rely on their big trades going the right way all the time and needs to plan accordingly.

Football is the beautiful game. Trading by contrast is simply a game, whether it appears "beautiful" is another question.

To read more about this topic please see the below work I've done, which describes the impact of the World Cup historically on markets. My book Trading Thalesians also has a chapter where I discuss what ancient Greek sport can teach us about trading (mixed in with a bit of ancient history).

Thalesians - Jules Rimet still gleaming - Impact of World Cup on financial markets -3 Jun 2014 (available for Thalesians clients only)

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What's beta in FX?

For my very first post on the Thalesians blog, I feel that I should tackle the notion of what is beta in FX. If you haven't spent a long time in FX markets, it can seem somewhat confusing to understand what should be a benchmark or "beta" to use a bit of market jargon. In equities, we have the S&P500 which can be used as a beta for long only investors. Similarly, in bond markets, we have various global indices produced by a multitude of banks, including Citi, Barclays and JPMorgan. Even in these cases though a beta is still something which isn't quite concrete.

In FX, there is no such obvious "beta". Furthermore, the notion of a long only investor can be confusing in FX. It is difficult to identify a "long only" investor in FX. After all, if you undertake an FX trade, for example long EUR/USD, you are simultaneously long one currency and short another. Hence, in order to understand what market beta is in FX markets, we need to adopt a slightly different approach. First, we need to have an idea of the typical factors which FX funds use to trade. 

Perhaps, the most common strategies which are used to trade FX, are those which involve carry and trend, as well as value. Of course there are many other common FX strategies, such as using relative interest rate differentials, modelling flows and using macro based models. Our aim is not to create an exhaustive list, but simply to understand the most common. By definition a "beta" strategy is one which can capture the returns of the market and generally requires less "work" than an "alpha" strategy.

If we purely focus on carry and trend, possibly the most popular FX strategies, we can create very generic versions. Carry involves buying high yielding currencies and selling low yielding currencies. In effect, it is a way of capturing a risk premium within FX markets. Hence, it can suffer from asymmetric returns, steady profits, but then suffering large drawdowns when there is risk aversion. A generic version of carry, simply needs to create a rank of the deposit yields on currencies. Trend strategies, as the name obviously suggests, attempt to buy high (and sell even higher), and sell low (and buy even lower). We can create a generic trend model using relatively simply technical indicators such as moving averages.

Once we have created these generic carry and trend models, we can regress them against the returns of a FX fund index (such as HFRX Currency Index). This enables us to find weights for our generic carry and trend models, which should proxy FX fund returns. We can then create a weighted portfolio of carry and trend, which as we see below does actually proxy FX fund returns pretty well! Hence, at least on a broad based level, it does appear that carry and trend seems to capture a lot of what FX funds do (see plot at the top!).

To read more about this topic please see the below work I've done, which goes through the subject in more detail. My book Trading Thalesians also has a chapter on alpha and beta (mixed in with a bit of ancient history).

Thalesians - Beta'm Up - What is market beta in FX - 30 Aug 2013 (Download from SSRN)
Handbook of Exchange Rates (Wiley) - chapter on FX market beta by Saeed Amen & Geoff Kendrick

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