Carry Trade - Retail Trader?

[BlowFish 10]

Is the carry trade as popular as it once was? I wonder if it has a role in the small traders arsenal. I was not thinking as a highly leveraged trade but more as a way of making capital work that sits idle in a variety of brokerage and bank accounts, more of a short term 'investment' with minimal leverage. Does this sound plausible?

 

I guess the chief thing to be wary of is interest rate changes (particularly un expected ones) in one of the pairs. Would a small basket (maybe 2 or 3) of preferably loosely correlated pairs help? I guess so but at a cost.

 

Any other tips and tricks or more importantly pitfalls to be aware of?

 

Thanks.

[GammaJammer 10]

Couple of points to remember

 

1) The carry trade (in terms of benefitting from the interest differentials) requires that you be long carry. As such, you are also hoping that any movement in the FX rate will not totally wipe out what you gain from the carry. That is also why it turned into a virtuous circle in the last few years. Investors were getting positive carry AND the rate was moving in their favour. As close to a market no-brainer as you're likely to get these days.

 

2) That era seems to be over for the the time being. Long Carry, particularly AUD/JPY and NZD/JPY were hugely crowded, very high conviction trades prior to this time last year, and that is why, when the subprime crisis started to really bite (and spread) they saw such sharp corrections (too many fat people trying to fit through a very small doorway).

 

3) The retail crowd (including the famous 'Japanese Housewives' were just as caught up in this as anyone.

 

4) To make carry work for you on a retail platform you also need to remember that the spread between bid and offer on the interest rates is larger than that which the wholesale players are working on. As you are talking about the rate that you can get for depositing the long (i.e. 'carry') currency (the bid in other words) against your borrowing cost in the short (i.e. 'funding') currency, this wider spread situation isn't a minor annoyance - depending on your broker it can be huge. Even the difference in some marginal cases between a positive carry situation and a negative one. In fact, with wide enough spreads and two currencies that are close enough together in interest rate you can easily be in a situation whereby you are negative carry no matter whether you are long OR short the pair. In a word, Ouch!

 

5) If you're thinking of trying to do this across two brokers (to arb their MM rates) you need to be sure there's no cost to transfer funds across all the time back and forth, as, unless you're very highly capitalised, that's what you're likely to be doing.

 

As I said, just a few things to think about. And by no means all you need to know before wading into the carry trade.

[BlowFish 10]

Thanks GJ, food for thought.

 

A Kllienwort analyst wrote "when the 'unstoppable force' of cheap yen is about to hit the 'immovable object' of the economic slowdown. Whiplash is likely in the months ahead.” That was two years ago but possibly even more relevant now.

 

1) This is the big thing to watch out for in my naive eyes. It's kinda pointless making a $100 a night from the interest if the yen advances 100 pips against the majors. I guess the interest rate differential is one of the key drivers for a pair but there are all sorts of other things (apart from a change in one of the interest rates) that could cause things to unravel pretty quick. This is the big thing for me to get my head round. I guess I would still be trading just aiming for positions in pairs where carry works for me rather than against me. It seems naive to suppose that long NZD.JPY is a better proposition than short based on interest alone but it must be a fairly big part of the equation?

 

2) I kind of figured the real milk and honey days might be over. There still seems to be a good differential in some rates but that's no good if the pair isn't pumping along in the right direction as you mentioned in item 1.

 

4) & 5) I think I should be OK here (but its something to check) My broker is offering rates that look fairly close to central bank rates. In fact there sterling rate looks better than Libor which is weird? Actually must be a mistake thinking about it. I don't plan to be moving stuff between brokers that sounds complicated

 

At the moment the majority of my funds are in sterling which gets OK interest but I have sat idly by and watched the GBP following the USD down the wazoo. I just figured I should be more pro active with my capital maybe I should just be moving it around a bit rather than specifically looking for carry trades? Is being short one currency and long another (i.e. holding a position) any more risky than just being 'long' a single currency (i.e. having money on deposit)? I am not sure to be honest.

 

Anyway thanks again GJ

[atto 20]

An option is to swing/position trade pairs with a carry, in the direction of the positive swap. The "goal" is to make pips, and you're collecting swap along the way.

[BlowFish 10]

Yes, thats another way of looking at it Atto. It has to be at least a day to get the interest of course. That may be a better way of looking at things. Look for a swing trade in a suitable pair and take the carry as a bonus, a 'dividend' if you like. I guess something like AUD/YEN would be a good pair to look at and maybe CHF and something? I was thinking taking a couple of positions in fairly uncorrelated pairs might help minimise 'blips'.

 

Does anyone publish correlation figures or is it a job for excel?

[atto 20]

Here is a correlation chart that you can change depending on your needs:

http://www.mataf.net/en/forex/trading/correlation/table/

 

You also might want to check out volitility figures on the same site, as that could play a part into how you trade it.

 

Remember, though, that during extreme market conditions, correlations can't be trusted. Things unwind in seemingly weird ways, which can put all your positions against you. An applicable case in point would be "correlated" forex pairs for carry trades. As one pair unwinds, people start to take out their entire carry. Also, you'll generally be paying the swap for currencies correlated against what you want to trade, and given the "protection" can be false, you may not end up on top.

 

If you trade 5-20 day swings (or longer), the carry can help your trade. Anything less than that, and comission / spread eats up any carry you'd collect. Entering a carry pair just to collect the swap is like buying a stock just for the dividend.. sometimes it's just a stupid idea.

[BlowFish 10]

Thanks Atto, I think it's probably better to look for swing trades that make sense and be mindful of the cost of carry rather than the other way round. Still need a lot more chart time especially during 'extreme conditions'. Mind you most instruments, especially the thinner ones, can get a bit weird now and then.

 

Cheers.

[Bwxb 10]

The carry trade can be tough at the retail level becuase of the rates the buckets pay are usually a rip off.

 

Go with the a non-mm and your off to a good start.

 

Another thing on "hedging" - There is no such thing in FX. In the real interbank market there was no such thing. You buy then sell to exit. Yes you can have a long and a short but it was / is done by a multiple alloc. breakdown.

 

This "hedging" term was created by the buckets drum roll - It allows them to double roll you.

[Bwxb 10]

It can be touch for retail becuase the rates at the buckets aren't usually the best. Much better at a prime broker.

 

Another thing - the buckets this "hedging" nonsense because they can double roll you.

 

Typically at a PB and on all of the top institutional platforms there is no such thing. If you want to initate a similar style say for example to scalp around a core postion you would use a mutiple allocate breakdown.

[snackly 10]

  Bwxb said:

The carry trade can be tough at the retail level becuase of the rates the buckets pay are usually a rip off.

 

Go with the a non-mm and your off to a good start.

 

Another thing on "hedging" - There is no such thing in FX. In the real interbank market there was no such thing. You buy then sell to exit. Yes you can have a long and a short but it was / is done by a multiple alloc. breakdown.

 

This "hedging" term was created by the buckets drum roll - It allows them to double roll you.

 

I don't think that's correct is it? You can hedge a long FX spot position by buying the put at the money, and the reverse for a short FX spot position.

 

If you do this on an ECN like IB, which lets you trade FX options, futures (CME) and spot FX (IDEALPRO), you can fully hedge your trades.

 

You could theoretically do this with bucket shops, but say you short the EUR.USD and then buy the call on IB at the money. The problem as I see it is that the bucket shop could theoretically (although unlikely) take the EUR.USD up when its going down. Not quite likely in a real large movement but just the possibility means its out of the question for any trader with serious risk management.

 

And in any case the hedge on IB against a spot position at an FCM bucket shop would fail if you weren't highly capitalized because you'd get a margin call, they don't care that you have the option at another broker.

 

If you trade them through the same broker, you'd never get the margin call since you'd be in the money with the put as your short trade is losing, and you would of course have a stop loss order anyway, so that your losing trade if it goes far enough has the opportunity to be a winning in the money option exercise.

 

Worst case you're out the premium.