Reviving the Carry Trade with Exotics
10/18/2012 9:00 am EST
Tyler Yell of DailyFX.com adds to his previous article on exotic currency pairs with a strategy that can be used in conjunction with your main trading plan.
In my last article, we touched on why you should consider exotic FX pairs in your trading plan. Now, we’re going to introduce a distinct fundamental aspect to trading exotic FX. Exotics are the main place where you still have the ability to earn interest like a bank does when they loan money so you can employ the Carry Trade strategy.
What is the Carry Trade and Who Is It Best For?
The carry trade is a buy-and-hold strategy that is best for yield hunters and trend followers. It’s not as exciting as day trading at first. However, if the conditions are right, this can be an excellent addition to your FX trading plan. The carry trade is a powerful set up where a trader looks to gain not only on the profit or loss of the pair going in the direction of the trend, but a strategy that allows you to collect interest payments. You can collect interest daily if you buy the higher yielding currency and sell the lower yielding currency. This presents a unique opportunity in FX trading that in the current low-interest-rate environment is best found in exotic pairs. Picking the right market condition and pair is key to the successful carry trade.
The New Carry Trade Players
Major currencies have slashed their overnight bank rates and rollover payout to take them out of carry trade consideration, so they can spur economic growth through low-interest borrowing. Here are some interest rates of exotic currencies that you can take advantage of by utilizing the carry trade.
OK, how do we find out the payout of these currencies against lower yielding currencies?
Look to the FXCM Trading Station 2.0 Dealing Rates:
Once you've found an attractive rollover, here are two things you need to look at to see if you should take advantage of this as a carry trader:
- Does the rollover pay out in the direction of the overall trend?
- Depending on how long I’m wanting to hold the trade, is this worth it to me?
NEXT PAGE: Examples of the Carry Trade|pagebreak|
The EURHUF has the highest rollover payout in the direction of the trend. Requirement one is met because the payout pays in the direction of the trend. This is not an uncommon play because currency strength is often dictated by interest rates.
The payout on a Sell EURHUF 100k trade is $12.00 per day on the RollS. The FXCM LLC margin required is $7,500 with an annual interest payout of roughly $4,380 or 4.4% on the entire 100k position and more on the margin required. To date we’re in a 4,620 pip down trend, which would add $21,437 onto the trade had we held this trade throughout the year.
Requirement two asks if it is worth it for you to hold on to the trade given the rollover. Notice how the RollS or rollover on the sell trade is positive. This means when I sell the pair I earn the interest. Because my interest payment and trend are aligned in the same direction I want to be a seller on this pair.
This trade was hand-picked, but the purpose of the article is to build the behavior in you of looking toward exotics for a carry trade opportunity.
We do not advise trading only for the rollover even though the payout on one side of the trade can be inviting. Pull up a longer term chart and make sure you’re not trading against the overall trend.
When dealing with exotics, the trends can go on for months and move sharply. If you are on the wrong side of a strong trend you can get stopped out quickly and the interest gained on the rollover payments can be diluted quickly by the loss on the trade.
Here is a chart of the USDMXN for 2012. Notice the two large trends, one up and the other down. You’ll see why it’s not worth holding onto the trade countertrend just to pick up the rollovers available:
To summarize, we only want to use the carry trade strategy if you’re willing to stay in the trade for the long term and if the currency pair’s trend is in the direction of the worthwhile payout.
Tyler Yell can be found at DailyFX.com.