This week, the DailyFX Dynamic Carry Trade Basket was up by 525 pips and accumulated and additional $164 on interest payments. Even though,U.S. credit markets remain very tight, with Junk bonds spreads above 400, credit conditions have eased since August and the appetite for carry trade seems to be back. The most profitable trade we took was the long position in the Australian dollar with 264 pips gain. On the other hand, the biggest loss was taken in the short position we held in the Japanese yen (82 pips). Last week, “we decided to open a long position in the kiwi with a stop in a weekly close below 0.6500”. We also said that, “we believe the sharp decline in the New Zealand dollar since July will act as a significant boost to the economy and we expect the effects of higher commodity prices will soon be translated into stronger exports”. Since then, the New Zealand dollar has rallied 131 pips and we think we are still in the beginning of major U.S. dollar depreciation. Good luck with your trading for the week ahead!
Additional Information
In an ever changing world, making profitable carry trades* (definition below) 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
What is Carry Trade
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.
Protective Stop-Loss
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.
Position Sizing
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.