Broad risk trends have once again taken the helm of the broad financial markets. For the currency market’s the interest in the ebb and flow of risk sentiment has attached itself specifically to the popular carry trades. Over the past few weeks, risk appetite (and in turn carry demand) has gone back and forth. Just at the turn of this week, traders’ confidence in steady markets and consistent appreciation in already overbought speculative assets was shaken by reports that major hedge funds were failing to repay loans and meet margin calls.
These concerns accompanied a week of central bank reports that reminded market participants that divergent interest rates were exacerbating a sticky credit market – where the cost of debt against default rose to a record. However, the Fed may have revived interest in the carry trade just this morning. In an unexpected move, the monetary authority announced it would expand upon its previous efforts to improve liquidity through its TAF program with a new endeavor dubbed the Term Securities Lending Facility (TSLF) which will make up to $200 billion in Treasuries available to banks in return for federal agency residential-mortgage-backed securities. Despite this effort though, the pressure underlying the credit and financial markets is still oppressive; meaning the outlook for the carry trade is still forbidding.
[I]Is Carry Trade a Buy or a Sell? Join the DailyFX Analysts in discussing the viability of the Carry Trade strategy in the [/I][I]DailyFX Forum[/I]
[B]What Are We Currently Long?[/B]
NZD/USD
AUD/USD
GBP/USD
[B]Interest Rate Ranking
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The Interest rate used to benchmark the currency basket is the 3 months Libor rate
[B]Last Week’s Profit & Loss
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[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.
[B]DailyFX Dynamic Carry Trade Index Equity Curve
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[B]Past Trades[/B]
Nov-07 Stopped out in the long USD/JPY position in a weekly close bellow 114. Sep-07 Opened a long Position in the New Zealand dollar Sep-07 Closed long positions in both the Swiss franc and Hong Kong dollar (Stop losses were triggered) Jun-07 Closed a long position in the New Zealand dollar, to minimize the impact of more RBNZ interventions Apr-07 Opened a short Position in the yen following the recent lack of inflationary pressures in the Japanese economy Feb-07 Closed a short position in the Japanese yen after the BoJ increase of the overnight rate to 0.50 percent Jan-02 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 (0.0100*10K) = 3 lots. In case the final result is not an integer you should always rounded it down to limit your exposure.
[I]For more from the Fed, check out our latest report topping the DailyFX headlines…[/I]