The term ‘Carry trades’ is a common subject among veteran forex traders; everyone remembering a situation where rising interest, along with an evaluating currency, yielded longer term investors with phenomenal returns. Since then, the economy has flip-sided, forcing these once considered to be “sure investments”, into chaos. From amazing highs, Yen crosses have dropped over the past year, characterized by increasing volatility. While only few managed to maintain their positions profiting from the whole drive south, many investors were whipsawed on numerous occasions, forcing their positions into a loss.
Even though carry trade articles have been flogged over the past year, I would like to just explain the basics, as understanding the term will help us decide on our future positions.
A carry trade is a term used when one buys a high yielding currency and sells a low yielding one. The investor aims to grab the difference in interest while profiting from the increase in value of the pair itself.
For example, throughout 2007 Australia was presenting an enormous return compared to Japan: An approximate 7% compared to Japan’s 0.5%. Sounds like a dream come true, no?
Well basically it was, especially as benchmark indices were averaging in their better years around 11%.
Further information regarding carry trades can be found in dodjit’s school for traders.
So what went wrong?
After 5 years of growth and exploitation of the financial system, things began to fall apart. The U.S housing sector dropped, causing a snow-ball effect throughout the economy. Consumer consumption dropped by an enormous rate forcing central banks to take monetary actions. Australia for example, was recently forced to cut its rate to 3% - the lowest rate in 49 years, due to the recession, one that caused a severe drop in demand of their natural recourses. Even though recent numbers have slightly improved in Australia, statistical analysis has shown a massive decline since the middle of 2008. An additional economy hit by the global slowdown is New-Zealand. A country well known for its exports to middle eastern countries, among others, is expected to slash its rates one more time this week due to the lack in global demand, bringing its rate down to a mere 2.5%. While some are still focused on which one of the major economies is going to be the first to reach the U.S’s 0.25% rate,
There are others that are looking past the rate cuts.
Think about it, after so many rate cuts, do you think one or two more cuts are going to make any significant difference?
Recent stock market action has led investors to believe that the markets are starting to bottom out. When observing the price pattern, one can see that the major U.S indices have increased for six weeks straight, smashing through psychological resistance levels. While many have been anticipating a major correction, pullbacks have been characterized by one-off days, which were quickly countered by bullish intraday rallies the following session. When observing the charts carefully one can see on the weekly chart below, that this week’s close was the first time in over a month and a half, whereas the weekly close was below the previous one.
*courtesy of stockcharts.com
What does this mean for Carry Traders?
Well it really depends what type of trader you are. Risk appetite has increased over the last few weeks as the stock markets have rallied. Even though central banks are expected to continue with their methods to stimulate the economy, analysts are expecting 2010 to be the end of this painful recession. If their predictions are realized, major economies' leaders could soon enough flip to a more tightening scenario, preventing economic growth from rising too fast.
AdsSpy: 3 sites by this AdSense ID
One must remember that central banks normally try to control GDP and inflation levels - maintaining moderate growth while preventing rapid inflation.
When observing the following charts one can see that carry trade buying has already started, sending the prices in the same direction as stocks. Even though economic data is showing a gloomy picture, investors are looking past the data, focused on a brighter future. While certain carry trades, for example the GBP/JPY, are currently presenting setups, one must note that a fair understanding is required when trading these certain pairs. Their high volatility can easily force new traders into losing positions, yet on the other hand provide the more acquainted with profitable trades.
Throughout 2008 the GBP/JPY, AUD/JPY and NZD/JPY dropped significantly compared to the USD/JPY (see daily chart). Carry trade closing along with declining interest rates sent these pairs plummeting.
With confidence slowly returning into the markets and equities seeing higher terrain, the only question that remains is whether those same carry trades will repeat their trading history? Will the GBP/JPY, AUD/JPY and NZD/JPY outperform the USD/JPY similar to 2004-2008?
Daily comparison
Weekly Comparison
*courtesy of netdania.com
Information reliability and liability: The contents are solely aimed for the use of "Experienced" investors in the financial markets who are fully aware of the inherent risk of trading. dodjit does not accept any liability for any loss or damage whatsoever that may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in our trading recommendations. dodjit makes no warranties or representations in relation to the Information (including, without limitation, in relation to its accuracy or otherwise) and do not warrant or represent that the services will be error free or uninterrupted. Copyright: This article is subject to and protected by the international copyright laws. Use of the information brought in this article is subject to making fair use only in accordance with these laws. It is not permitted to copy, change, distribute, or make commercial use of the information except with permission of the holders of the copyright. Risk Disclosure: The risk of losses involved in the transaction or speculations in the financial markets can be considerable. Please think carefully whether such trading suits you, taking into consideration all the relevant circumstances as well as your personal resources. Speculate only with funds that you can afford to lose.
enjoy
dodjit
Even though carry trade articles have been flogged over the past year, I would like to just explain the basics, as understanding the term will help us decide on our future positions.
A carry trade is a term used when one buys a high yielding currency and sells a low yielding one. The investor aims to grab the difference in interest while profiting from the increase in value of the pair itself.
For example, throughout 2007 Australia was presenting an enormous return compared to Japan: An approximate 7% compared to Japan’s 0.5%. Sounds like a dream come true, no?
Well basically it was, especially as benchmark indices were averaging in their better years around 11%.
Further information regarding carry trades can be found in dodjit’s school for traders.
So what went wrong?
After 5 years of growth and exploitation of the financial system, things began to fall apart. The U.S housing sector dropped, causing a snow-ball effect throughout the economy. Consumer consumption dropped by an enormous rate forcing central banks to take monetary actions. Australia for example, was recently forced to cut its rate to 3% - the lowest rate in 49 years, due to the recession, one that caused a severe drop in demand of their natural recourses. Even though recent numbers have slightly improved in Australia, statistical analysis has shown a massive decline since the middle of 2008. An additional economy hit by the global slowdown is New-Zealand. A country well known for its exports to middle eastern countries, among others, is expected to slash its rates one more time this week due to the lack in global demand, bringing its rate down to a mere 2.5%. While some are still focused on which one of the major economies is going to be the first to reach the U.S’s 0.25% rate,
There are others that are looking past the rate cuts.
Think about it, after so many rate cuts, do you think one or two more cuts are going to make any significant difference?
Recent stock market action has led investors to believe that the markets are starting to bottom out. When observing the price pattern, one can see that the major U.S indices have increased for six weeks straight, smashing through psychological resistance levels. While many have been anticipating a major correction, pullbacks have been characterized by one-off days, which were quickly countered by bullish intraday rallies the following session. When observing the charts carefully one can see on the weekly chart below, that this week’s close was the first time in over a month and a half, whereas the weekly close was below the previous one.
*courtesy of stockcharts.com
What does this mean for Carry Traders?
Well it really depends what type of trader you are. Risk appetite has increased over the last few weeks as the stock markets have rallied. Even though central banks are expected to continue with their methods to stimulate the economy, analysts are expecting 2010 to be the end of this painful recession. If their predictions are realized, major economies' leaders could soon enough flip to a more tightening scenario, preventing economic growth from rising too fast.
AdsSpy: 3 sites by this AdSense ID
One must remember that central banks normally try to control GDP and inflation levels - maintaining moderate growth while preventing rapid inflation.
When observing the following charts one can see that carry trade buying has already started, sending the prices in the same direction as stocks. Even though economic data is showing a gloomy picture, investors are looking past the data, focused on a brighter future. While certain carry trades, for example the GBP/JPY, are currently presenting setups, one must note that a fair understanding is required when trading these certain pairs. Their high volatility can easily force new traders into losing positions, yet on the other hand provide the more acquainted with profitable trades.
Throughout 2008 the GBP/JPY, AUD/JPY and NZD/JPY dropped significantly compared to the USD/JPY (see daily chart). Carry trade closing along with declining interest rates sent these pairs plummeting.
With confidence slowly returning into the markets and equities seeing higher terrain, the only question that remains is whether those same carry trades will repeat their trading history? Will the GBP/JPY, AUD/JPY and NZD/JPY outperform the USD/JPY similar to 2004-2008?
Daily comparison
Weekly Comparison
*courtesy of netdania.com
Information reliability and liability: The contents are solely aimed for the use of "Experienced" investors in the financial markets who are fully aware of the inherent risk of trading. dodjit does not accept any liability for any loss or damage whatsoever that may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in our trading recommendations. dodjit makes no warranties or representations in relation to the Information (including, without limitation, in relation to its accuracy or otherwise) and do not warrant or represent that the services will be error free or uninterrupted. Copyright: This article is subject to and protected by the international copyright laws. Use of the information brought in this article is subject to making fair use only in accordance with these laws. It is not permitted to copy, change, distribute, or make commercial use of the information except with permission of the holders of the copyright. Risk Disclosure: The risk of losses involved in the transaction or speculations in the financial markets can be considerable. Please think carefully whether such trading suits you, taking into consideration all the relevant circumstances as well as your personal resources. Speculate only with funds that you can afford to lose.
enjoy
dodjit
