The Carry Trader – What Forex Style Suits You?
A carry trade is the term given where an investor sells a currency with a relatively low interest rate to buy a different currency yielding a higher interest rate. An example of the trade in the AUDJPY would be where an investor buys AUD to invest at a yield of 3.85%, selling JPY, costing 0.55% on the JPY amount sold (or borrowed). They stand to make 3.3% per annum so long as the exchange rate does not change.
Traders are attracted to these trades as the gains can become very large when leverage is taken into account. If the trader in our example uses a commonly used leverage ratio of 10:1 they can earn a profit of 33% p.a. The big risk is the uncertainty of exchange rates. If the AUD were to fall against the JPY the trader would lose part of their return. If the AUD fell far enough they would start to lose capital.
Because these trades are done with leverage, small movements in spot can cause significant losses, requiring that traders hedge. Selling can trigger further selling and on occasions the corrections can be violent. For that reason it is important to control downside risk.
Famous Trend Trader:
Julian Robertson - The Yen Carry Trade 1995 -1998
Experienced traders control risk, inexperienced traders chase gains
Between 1995 and 1998 USDJPY appreciated more than 66%, in part due to more and more traders financing high yielding assets by borrowing JPY.
A trader who got in around the bottom would have collected around 15% on the interest rate differential to add to their 66% exchange rate gain. If they had been geared 10 to 1 they would have made around 800%. No wonder the trade got more and more popular.
But a day of reckoning was to come. Julian Robertson of the Tiger fund was just such a casualty in the unwind. In a particularly bad day for him on October 7, 1998, the Tiger Fund lost a whopping $2 billion when the yen gained more than 8% against the U.S. dollar.
5 Facts About Carry Trading
1) Profit Generation
A long carry trade generates profit off the difference in interest between the higher and lower yielding currency
2) Potential Losses
Losses can be incurred quickly during periods of risk aversion where investors exit carry trades in pursuit of safer lower yielding asset classes (i.e. US Treasuries)
3) Volatile Pairs
Carry trade currency pairs can be extremely volatile due to the volume of “hot” money transitioning through high yield currencies over short time periods
4) The Long Term
Significant profits can be earned over time through the carry trade meaning it can be an excellent addition to a trader’s long term strategy portfolio
5) Popular Currencies
One of the most popular carry trades is the Australian Dollar against the Japanese Yen
Carry Trading On MahiFX
1) Identify Good Entry Levels
As the carry trade currency pairs can be extremely volatile it is extremely important to time your trade well. MahiFX charts and technical indicators are ideal for this purpose.
2) Scale Positions
You may want to scale your carry trade positions up and down which is easy to do inside of a book.
3) Apply Stop Losses
The application of stop loss and take profit orders against your carry trade is simple, and they also automatically resize to reflect the size of your position
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