Fortunately Carry Trade Loss

Fortunately Carry Trade Loss

In essence, Carry Trade is a forex trading system with more priority to profit from difference of interest rate, not from price change.

Carry Trade is trading by utilizing the difference in interest rates between two currencies. Carry-Traders could suffer losses if the value of the borrowed currency to finance the Carry Trade is strong, or the target currency weakens, and may be a combination of both. How come? What is Carry Trade? Here are more reviews on how to trade Carry Trade and tips to make a profit while avoiding loss when using this way of trading.

How to Trade Carry Trade

In essence, Carry Trade is a way of forex trading by prioritizing the profit of the difference in interest rates between currency pairs traded, NOT profit from exchange rate changes among the currency itself. At the time of Carry Trade, a trader buys a currency with a higher interest rate, and at the same time sells currency with lower interest rates. In order to maximize profit, a Carry-Trader buys the currency with the highest interest rate and sells the currency with the lowest interest rate.

If the current Australian dollar rate is 3.25% per annum and the Japanese Yen is 0.1% per annum, then with AUD / JPY buy, a Carry-Trader will benefit from:

  • buy AUD, the trader earns 3.25% interest.
  • at the same time sell JPY, trader pays 0.1% interest.

If the AUD exchange rate against JPY remains the same, or the relative is not moving too significantly; then within a year, a Carry-Trader will earn a 3.15% profit from the interest difference between the two currencies. If the trader is trading with a standard (regular) lot or AUD 100,000 contract size, then he will earn 3.15% interest per year. If trading with a leverage of 200: 1, then with AUD 500 margin will get AUD 3,150 from interest rate difference.

Currency For How To Trade Carry Trade

The Liquid Currency Pair.

Currencies are often transacted in the way of trading Carry Trade especially currency pairs worldwide and liquid. The goal is that at any time easy to find partners, both for buy and sell transactions, at the desired price level. Included among these global and liquid currency pairs are USD, GBP, JPY, AUD, CAD, CHF, and NZD.

Interest rates from developing country currencies such as Indonesia or Turkey are usually very high, but less liquid. Therefore, in the market rare transactions, and will be difficult to reach agreement on the sale price at the expected price level.

High Interest Rate Difference Between Currencies in One Place.

To do Carry Trade, it takes two currencies with high interest rate difference in one pair. Like the AUD / JPY example above. Therefore, the Carry Trade trend may vary from one pair to another, in line with changing interest rates in each country of origin.

Several years ago, the NZD / JPY couple was quite popular for Carry Trade. Traders take a buy position on this currency pair, not because of New Zealand’s economic growth; but because the interest rate NZD then 8%, while JPY 0.5%. The 7.5% interest rate is good for the fund manager, not to mention the opportunity to gain profit from the buy position if the NZD strengthens against the yen.

However, as the New Zealand dollar rate decreases (now 2.5% per year) and Australia’s central bank policy to raise interest rates gradually, the Carry-Traders begin to shift to AUD / JPY.

Relatively Stable Currency Exchange Rate.

By way of trading Carry Trade on NZD / JPY and AUD / JPY, fund managers can reap profitable profit, until the global financial crisis in 2008. At that time, the Australian dollar fell sharply against the Japanese Yen with high volatility (bottom figure) to carry traders suffered losses and was forced out of the market. They just returned a year later.

Reported also on Bloomberg on 13 November 2012 that the Carry-Trader suffered the biggest loss since 2011 due to the strengthening US Dollar. At that time, the US Dollar was one of the favorite currency for Carry Trade in addition to the Japanese Yen and Swiss Franc, due to the second lowest US interest rate after Japan.

Effective Time For Carry Trade

Although Bloomberg news sites call it “easy profit”, but the way of trading Carry Trade is not as easy as traders in general, especially in determining the right time to enter the market. The big players of Carry Trade and investors representing banks or financial institutions always look and study the global economic cycle before taking a position.

When economic growth is solid and without much disruption, the trend of currency movement of a country will tend to strengthen and relatively stable. For the long term, this will benefit the Carry-Trader, because sooner or later the rate of inflation will surely increase, and the likelihood of interest rates will be raised. It was this situation that Carry Trade’s traders anticipated Carry Trade’s actions about the Australian economy when they began to buy AUD / JPY a few years ago.

Adverse Things For Trading Carry Trade

The Carry-Trader will usually exit the market or close its trading position if it happens:

High Average Daily Range Changes.

Volatility is the main factor that Carry-Traders must pay attention to. If there is extreme sentiment in financial markets, then volatility will increase. This can be observed in the average range of daily price movements (Average Daily Range).

If the change in Average Daily Range gets bigger, then volatility is also higher. This can be monitored by the Average True Range (ATR) technical indicator, which is usually used to determine the magnitude of changes in the range of price movements in a certain period of time.

Interest Rate Withdrawal Bank.

If the state of the global economy is at high risk and has a negative impact on the market, some central banks will have a policy of cutting interest rates. This will cause Carry-Trader to review its trading position which is usually planned in the long run.

Volatility due to interest rate cuts usually occurs temporarily (short term), but since the cut is usually the target currency of the Carry Trade, then in the long run the profit due to the difference in the interest rate will obviously decrease. For example, the trader buys AUD / JPY, but then the Australian central bank cuts the interest rate. Clearly, this will impact on the decrease of Carry Trade’s interest rate for AUD / JPY buyers.

Government Intervention.

Although the frequency is small, the government may intervene in the forex market if the exchange rate is overvalued or too weak according to the central bank’s expected reference. With the intervention, then the value of the currency will strengthen or weaken quickly. This of course affects the volatility and exchange rate of the Carry Trade currency pair.

Conclusion

Extreme market sentiment is not always the case, nor is volatility high. The forex market and the stock market will usually recover along with the increase in returns it generates. Investors usually wait for the most suitable or near-ideal conditions for Carry Trade trading, ie if global economic conditions are growing rapidly with interest rates in some countries competitive enough.