Direction accuracy, forecasting error and the profitability of currency trading: simulation-based evidence

A simulation exercise is conducted to find out if the profitability of forecasting-based currency trading is more related to the ability of the underlying model to predict the direction of change than the magnitude of the forecasting error. Theoretical considerations show that a correct prediction of the direction of change is neither a necessary nor a sufficient condition for a profitable trade. The results of the simulation exercise indicate that profitability is more strongly correlated with direction accuracy than with the root mean square error.