Risk aversion continues to be the main theme on today?s financial markets but we think investor?s appetite for Carry is likely to return. This week, the DailyFX Carry Trade Basket was relatively unchanged in capital. Yet, our basket earned nearly $120 on interest payments and 3 out of five trades were profitable.
The most profitable trade was the long position we held in theSterling (171 pips). On the other hand our biggest loss was taken in the Swiss franc (197 pips). This loss was offset by the interest we received by shorting the franc (+$39.20)
No changes were done in the components of the basket for the week ahead. Good Luck!
Viewed from a historical standpoint this is actually one of the smallest major drawdowns since the inception of the Euro (Click here to find out more).
[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.
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[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.
[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.