Interest in the carry trade continues to improve, but unevenly. High yielding currencies like the Australian and New Zealand dollars have seen a considerable bullish rally over the past week. On the other hand, low yielding currencies have not given up nearly as much ground as the high yielders have lost.
This hesitant rebound in interest comes thanks to the relentless deterioration in growth projections and potential problems for the credit and broader financial markets on the horizon that may stoke unwanted volatility. Last week, Fed Chairman Ben Bernanke and US Treasury Secretary Henry Paulson testimony on the economy revealed expectations of a deeper housing market slump and ongoing credit problems. Perhaps more concerning to carry traders specifically though is speculation that major bond insurers may split from their credit-ruining sub-prime departments and stripe some $580 billion worth of the debt of a reliable credit rating. Such a move could signal the next catalyst for another dive in the credit market.
[I]Is Carry Trade a Buy or a Sell? Join the DailyFX Analysts in discussing the viability of the Carry Trade strategy in the DailyFX Forum[/I]
[B]What Are We Currently Long?[/B]
NZD/USD
AUD/USD
GBP/USD
[B]Interest Rate Ranking[/B]
Interest rates High Yielders Low Yielders 3 Month NZD AUD GBP USD CHF JPY Libor Rates 8.85% 7.73% 5.61% 3.01% 2.69% 0.84
The Interest rate used to benchmark the currency basket is the 3 months Libor rate
[B]Last Week’s Profit & Loss[/B] [B][/B]
Open Positions Stop Price* Profit & Loss ( 01/14/2007 to 2/19/2008 ) Capital Gains Interest Received** LONG NZD/USD 0.65 +137 pips $70 LONG AUD/USD 0.7650 + 249 pips $56 LONG GBP/USD 1.9000 - 3 pips $44 [B] *Stop losses are activated when we have a weekly close below the specified stop level.[/B]
**The Interest Received is the dollar amount received per each 100K lot left open at 5:00 PM ET for an entire week.
Monthy Returns graph does not account for the discretionary trades DailyFX makes on part of the Dynamic Carry Trade Index
[B]Past Trades[/B] November 2007 - Stopped out in the long USD/JPY position in a weekly close bellow 114. September 2007 - Opened a long Position in the New Zealand dollar September 2007 - Closed long positions in both the Swiss franc and Hong Kong dollar (Stop losses were triggered) June 2007 - Closed a long position in the New Zealand dollar, to minimize the impact of more RBNZ interventions April 2007 - Opened a short Position in the yen following the recent lack of inflationary pressures in the Japanese economy February 2007 - Closed a short position in the Japanese yen after the BoJ increase of the overnight rate to 0.50 percent January 2002 - Opened long Positions in the NZDUSD, AUDUSD, GBPUSD, USDJPY, USDCHF and USDHKD
[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 (0.010010K) = 3 lots. In case the final result is not an integer you should always rounded it down to limit your exposure.