Investor?s appetite for carry trade seems to have returned to the world?s financial markets. This week, the DailyFX Dynamic Carry Trade Basket was up by nearly 294 pips and accumulated an additional $164 on interest payments. Moreover, four of our five trades were profitable and the most lucrative one was the short position we took in the Japanese yen with 210 pips. On the other hand, our single loss was taken in the position we held in the Sterling (-52 pips). In the past two weeks, the U.S. dollar has been recovering some of its yield support against the Japanese yen (graph below), nonetheless, like we said in our new weekly report Watch What the Fed Watches, the U.S. credit markets are still very fragile and an adequate protective stop is required to account for any unexpected carry unwind. Good luck with your trading for the week ahead!
In the past two weeks, the U.S. dollar has been recovering some of its yield support against the Japanese yen. Below is a graph with the interest rate differential between theU.S. and Japan for deposits maturing in one year.
Source: Bloomberg
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[B]Additional Information[/B]
[B][/B]In an ever changing world, making profitable carry trades* (definition below) 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.
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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. 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.