Risk appetite has stabilized and the carry trade found a shaky footing this past week thanks to an unusually quiet economic docket. However, this period may end up being the lull before another wave of deleveraging and high volatility. Over the past few days, though there haven’t been many market-worthy indicators that specifically influenced the taste for general risk or the health of the credit market, there have been a number of headlines that have added to the carry trade outlook.
On the positive side, the world’s largest financial corporation – Citigroup – announced it would sell $12 billion of its leveraged debt to a group of investors for 90 cents on the dollar. What’s more, major American bank Washington Mutual reportedly raised $7 billion on the market to help bolster its capital position. At the same time, there was more than a smattering of bad news. Interest in the Fed’s 9th auction through its facility lending program showed there was still overwhelming demand for liquidity. What’s more, an IMF report revealed that the group was expecting total losses from the credit crisis to reach a staggering $945 billion. Looking ahead to the coming week, we may see the carry trade back in play. The G7 will meet this weekend to discuss the financial markets; and the earnings season will begin in earnest.
[B]Performance Update: +653 pips[/B]
Is Carry Trade a Buy or a Sell? Join the DailyFX Analysts in discussing the viability of the Carry Trade strategy in the [I]DailyFX Forum.[/I]
[B]What Are We Currently Long?[/B]
[B]
NZD/USD
AUD/USD
GBP/USD[/B]
[B]Additional Information[/B]
Making profitable carry trades are not as easy as they use to be. Therefore we have created a dynamic carry basket that changes when the monetary policy outlook for a central bank changes or if there is significant event risk ahead. Follow the performance of the DailyFX Dynamic Carry Trade Basket
[B]
What is Carry Trade[/B]
All that is needed to understand the carry trade concept is a basic knowledge of foreign exchange and interest rates differentials. Money shifts from around the world in seek of the highest yield and the benefit of trading currencies is that you are dealing with countries that have interest rates, which are charged or received every single day. If you are positioned on the side of positive carry, you have the right to earn that interest, which can be quite lucrative over time.
[B]Protective Stop-Loss[/B]
Substantial gains made from interest rate differentials provide undeniable evidence that the carry trade strategy has been very successful over the past few years. Still, this strategy involves significant risks and an adequate protective stop is required. We are using a protective stop-loss equivalent to five times the average true range. Stop losses are activated when we have a weekly close below the specified stop level.
[B]Position Sizing[/B]
Our position size varies according to each currency volatility. Generally, the more volatile the currency is, the fewer lots we trade. For example, let’s assume you have $10,000 and you are trading 10K lots, you decide to limit your risk per trade to 3% or $300 and the 90 days average true range for the EURUSD is 100 pips. In this case, if you go long EUR/USD you could buy 3 lots, since ($10000 * 3%) divided by (0.0100*10K) = 3 lots. In case the final result is not an integer you should always rounded it down to limit your exposure.