Trading

The Carry Trade is one of the simplest strategies in forex, and if executed correctly, can also be one of the most profitable. The basic mechanics of a carry trade involve borrowing in one currency that offers a low interest rate, and selling it in favor of a higher-yielding currency, in order to capture the interest rate spread. This strategy carries two key risks. The first risk is that the "long" currency will depreciate. This also includes country risk, the possibility that political or macroeconomic instability will adversely affect the long currency. Then, there is the risk that the interest rate differential will change such that the spread shrinks, and a smaller carry is earned.

In a recent article for Seeking Alpha, financial journalist Ray Hendon offered an overview on the four principal strategies employed in the forex markets: carry trade, technical trade, fundamental trade, and arbitrage. The carry trade, which involves borrowing in a low-interest rate currency and buying a higher-yielding currency, can be undertaken by either buying ETF(s) or by trading directly using a retail forex account. The ETF route can be further subdivided into two possibilities: to buy a particular currency ETF to take advantage of the spread, or instead to buy one of two ETFs (symbols: ICI & DBV) that use computer models to mimic the carry trade.

WisdomTree and Dreyfus Funds recently unveiled five new currency ETFs in order to fill a broad gap in the emerging markets category. Previously, investors were limited to such mainstay currencies as the US Dollar, Euro, Japanese Yen, British Pound, Australian Dollar, Canadian Dollar, and Swiss Franc. These new ETFs will expand this list to include the Indian Rupee, Brazilian Real, and the much-anticipated Chinese Yuan. It will also offer products for the Euro and Yen, but these probably won't draw much attention. The RMB ETF, especially, will be pounced on by investors, who have been clamoring for years for a cheap and easy way to capture the upside of the Yuan's inevitable appreciation.

In recent months, the credit crunch has ignited a global trend towards risk aversion.  As a result, a correlation has developed between equities, which serve as a proxy for risk, and certain currencies.  The Forex Blog previously covered the link between the S&P 500 and the Japanese Yen, whereby the Japanese Yen moved inversely with the S&P as a decline in  risk appetite led carry traders to unwind their positions.

Through its trademark iPATH line of funds, Barclays Bank recently introduced a new ETN designed to mimic the carry trade.  In accordance with this strategy, this note is linked to  the performance of the Barclays Intelligent Carry Index, which aims sell low-yielding currencies and use the proceeds to invest in those that offer higher yields.  This index holds varying combinations of the so-called G10 currencies, which includes all of the majors as well as the Norwegian Krona and Swedish Krona.  Traditionally, carry traders have sold one specific currency (i.e.

Yesterday, the Forex Blog featured a story that explained how to make money when volatility is low.  The consensus of the article is that investors must shift their strategy from trading to trending, which requires an adjustment in outlook from short-term to long-term.  But given that volatility is low and that currencies often move laterally against each other, how do you know which direction to bet on, and accordingly, when to buy or sell?  The answer requires some minor technical analysis, involving two of the most basic tools available: support and resistance.