strategy

In general, the forex trading strategy known as the "Carry Trade" refers to an increasingly widespread forex
trading strategy that is usually implemented over longer term time frames and involves taking advantage of the interest rate differential prevailing between two currencies.

Furthermore, using such an interest rate strategy in your forex trading will make the most sense if you use a forex broker that provides particularly attractive rates on rollovers for the currency pair you are most interested in putting on a carry trade with.
Profiting From Interest Rate Differentials

Since carry traders basically look to capture the interest rate differential between two currencies, as well as hopefully some additional appreciation from favorable exchange rate movements, they need to choose their pairs wisely based on two primary criteria.

The first is the magnitude of the interest rate differential itself. The absolute value of this differential can be readily computed by subtracting the higher interest rate from the lower interest rate for each currency involved. The interest rates used will be those prevailing for Interbank deposit rates for the time period during which the carry trade will be kept on for.

The second consideration is the likelihood of appreciation of one currency versus the other. Since carry trades tend to be longer-term positions, a combination of fundamental and technical analysis is often used to arrive at this forecast.

For the best carry trade scenario, you will want to choose the highest interest rate currency that stands the best chance of appreciation against the lowest interest rate currency according to your forecast for the future exchange rate over your time frame of interest.
Carry Trade Profits and Risks

Not only do carry traders hope to capture the resulting favorable interest rate differential or "positive carry" as it is often called, but they usually also plan on benefitting from interest rate compounding effects, as well as from any currency appreciation seen.

The sum of these factors at the time the trade is closed out will determine their profit or loss on the carry trade.

In terms of risk management, the interest rate differential provides something of an initial protective buffer against losses that might accrue due to adverse exchange rate movements. Nevertheless, stop losses can be placed at strategic points that stand a reduced chance of being executed as an additional form of risk management. Learn more about the risks with carry trading.
Additional Profits or Costs of Rollovers

Rollovers of currency positions tend to be executed automatically by most online forex brokers if the position is held over the time of 5 PM Eastern Standard Time.

An automatic rollover means that the broker will automatically close out your existing forex position for value spot and roll it forward for value one additional business day in the future. Since rollover rates can vary substantially among forex brokers, make sure you choose a broker with competitive rollover rates if you intend to put on carry trades.

Generally, when forex traders have their currency positions rolled, they will get paid pips to do so if they are holding the higher interest rate currency. On the other hand, if they are holding the lower interest rate currency, they will pay pips away when their position is rolled over.
Hedged Carry Trades

Yet another type of carry trade involves hedging one long carry trade with another short carry trade using different currency pairs that are closely correlated and which results in a net interest rate benefit to the overall position.

For example, a hedged carry trader might exploit interest rate differentials between well correlated currency pairs like the following:

EUR/USD and USD /CHF

AUD/USD and NZD/USD

GBP/USD and USD/CHF

EUR/JPY and CHF/JPY

GBP/JPY and CHF/JPY

Such hedged carry trades are often highly leveraged to make them worthwhile, thus much more risky. Nevertheless, the main risk to this hedged carry trade strategy arises if the correlation between the pairs breaks down for some reason and subsequently results in losses. Remember that the correlation risk is of course not the only risk factor to consider, just one of them.
The Effect of Risk Aversion and Appetite on the Carry Trade

When risk aversion prevails among investors in the forex market and exchange rate volatility is high, the carry trade often starts to look less attractive since the riskier currencies to invest in tend to have higher interest rates.

On the other hand, when all seems well in the world and more stability has returned to the currency market, the risk appetite of investors then tends to increase and they start looking for higher returns on their money, even if it means taking more risk.
The Benefit of Compounding Interest

Another interesting element that favors the carry trade is the possibility of compounding your interest on a daily basis by rolling your carry trade positions over each day.

When the rollover spreads available for doing so are reasonably competitive, this can provide even more income for the carry trade compared with just rolling the carry trade position out for an extended period using a forex forward contract.

Read about the powerful effect compound interest has on the carry trade strategy.

Read our main article on carry trading.

See our comprehensive technical analysis section.

See our comprehensive fundamental analysis section.

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.
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There is a new sense of energy in the FX

There is a new sense of energy in the FX markets today but the rally has been contained to only a few major currency pairs. The biggest gains are being enjoyed by USD/JPY and USD/CHF but AUD/USD and NZD/USD also recovered nicely. Euro and sterling on the other hand are struggling to gain any type of momentum – upside or downside as the lack of market moving Eurozone data keep movements in these currencies limited.
At a time when the rest of the world economies are on shaky ground, U.S. economic data continues to surprise to the upside, making the dollar extremely attractive to global investors. Consumer confidence surged to its highest level in 5 years. Thanks to the improvement in the labor market and the persistent rise in stocks, the Conference Board’s measure of consumer sentiment rose to 76.2 in May, up from 69. Greater consumer optimism should hopefully translate into stronger consumer spending in the second quarter. The Richmond Fed manufacturing index also rebounded to -2 from -6. While this was the second month in a row that manufacturing activity contracted, the improvements is a breath of fresh air for the sector. Finally, house prices increased 1.12% in March after rising 1.32% in February. This represents deterioration but for the first quarter, house prices are up 10.17% vs. 7.25% in Q4. As U.S. economic data continues to improve, expectations for tapering asset purchases by the Fed will continue to build and this sentiment should fuel further gains in the dollar.
Meanwhile, the IMF’s report on central bank purchases of gold is getting some attention this morning and even though gold is lower, it is lending support to the beleaguered AUD and NZD. Investors have been eager to see whether the 18% decline in gold prices year to date attracted central bank buying and according to the International Monetary Fund, aside from Canada and Mexico, every major central bank has been hunting for bargains. Russia, Kazakhstan and Azerbajian collectively increased their gold holdings by 75%, cementing Russia’s status as the world’s number one buyer of gold. These 3 former Soviet Republics have been buying all the way down and while their demand has limited the slide in gold, it has not stopped it.
For most central banks, buying gold is part of their overall forex portfolio diversification strategy and the further gold declines, the more demand we expect because central banks are not as sensitive to short or medium term swings as traders or even investors. The outlook for gold hinges on the outlook for the U.S. dollar and for the time being, expectations for a reduction in asset purchases by the Fed should keep the dollar bid. According to the CFTC’s latest positioning data, fund managers and speculators are grossly short gold and we believe that the prices could head lower.

Euro and Pound Get Hit As Dollar Continues To Advance and Other Top Forex News.

The dollar extended Thursday’s gains into Friday as markets try to decide how to price earlier QE tapering talk. Fed Chairman Ben Bernanke said on Wednesday that monetary stimulus programs, which weaken the dollar to spur recovery, may be scaled back this year if the economy continues to improve.

With no U.S. data due for release today, most of the action was in the euro, which came under pressure after the European Central Bank said its current account surplus narrowed to EUR 19.5 billion in April, from a surplus of EUR 25.9 billion, confounding expectations for the surplus to narrow to EUR 14.2 billion.

The dollar was also stronger against the pound after official data showed that Government borrowing rose slightly in 2012-13 compared with the previous year. Figures from the Office for National Statistics show underlying public sector borrowing was £118.8bn, up from £118.5bn in 2011-12. The rise comes as a result of the ONS revising down its 2011-12 borrowing figure by £2.4bn to £118.5bn.

In U.S. trading on Friday, EUR/USD was down 0.73% at 1.3123, up from a session low of 1.3116 and off from a high of 1.3254. GBP/USD was down 0.45% at 1.5439, off from a session high of 1.5532.

More Coverage of the Day’s Top Story

FT: Dollar gains as EM currencies suffer. – The U.S. dollar gained further ground at the end of a turbulent week in foreign exchange markets during which emerging market currencies bore the brunt of the selling.
FT: Forget the Fed – it’s the ECB that should worry investors. Investors have been heading for the hills over the U.S. Federal Reserve’s warning that it may soon rein in its ultra-loose monetary policy. They may be worrying about the wrong central bank. An exit from crisis-era measures will be tricky everywhere. But most central bankers and their political masters have a clear idea of what normality they wish to return to. Not so the European Central Bank. For the euro area, it could get ugly.
Marc Chandler: Fragile markets trying to stabilize ahead of weekend. – A somewhat calmer tone has emerged in the global capital markets, encouraged more, it appears, by position adjusting ahead of the weekend, rather new fundamental developments.

More Top Stories:

The Australian: Australian dollar’s plunge likely to continue. – With global investors anticipating the start of the US central bank’s removal of economic stimulus before the end of the year, a move to US90c can be expected in coming weeks, analysts said.

New Zealand Herald: NZ dollar tumbles below US78c. – The New Zealand dollar fell to a 12-month low as the Federal Reserve’s signal of an end to quantitative easing, weak Chinese manufacturing and tighter credit sapped risk appetite and sent investors rushing to the greenback.

WSJ: Gold bounces off recent lows. – Gold prices rebounded from September 2010 lows as bargain hunters in Asia briefly lifted prices above $1,300 an ounce.

Bloomberg: Dollar index gains for 3rd day as Fed policy shift spurs demand. – The Dollar Index rose for a third day, surging after Federal Reserve Chairman Ben S. Bernanke made the case for reducing stimulus as the economy improves, sparking declines in emerging-market assets and commodities.

Future Currency Forecast: USD/JPY exchange rates. – ‘Greenback’ set to make biggest gains in two months. – The U.S. Dollar has strengthened against the majority of its peers and is heading for its biggest weekly gain in two months against the Japanese Yen, after having soared after Federal Reserve Governor Ben Bernanke made the case for monetary stimulus to be withdrawn as the US economy improves.

Investing.com: Gold inches up amid bargain hunting after Fed-fueled selloff. – Gold prices rose on Friday, edging up from lows not seen since September of 2010 after a manufacturing gauge for the Philadelphia area of the U.S. beat expectations and strengthened the dollar, which tends to trade inversely with gold.

Investing.com: USD/CAD gains on soft Canadian inflation, retail sales data. – The Canadian dollar tumbled Friday to its lowest level in a year Friday as the U.S. dollar continued to appreciate and traders digested data on retail sales and inflation.

Investing.com: GBP/USD trims losses, but remains under pressure. – The pound trimmed losses against the U.S. dollar on Thursday, but remained under pressure after the release of mixed U.S. data as Wednesday’s comments by Federal Reserve Chairman Ben Bernanke continued to support the greenback.

How High Can the Dollar Rise? Levels to Watch

This week marked a turning point in the financial markets.  The U.S. dollar ripped higher against all of the major currencies as Treasury yields soared and stocks plummeted. More specifically, the dollar appreciated 3.7% against the Japanese Yen, Australian and New Zealand dollars, 1.85% against the British pound and 1.7% against the euro. Ten year U.S. Treasury yields topped 2.5% intraday on Friday, reaching its highest level since August 2011 while the S&P 500 dropped below 1,600 adding to losses that now exceed 5% since May. The strength of the dollar drove many of the major currencies to key levels, most notably the comm dollars.  The Canadian dollar is now at its weakest level in 1.5 years and the Australian and New Zealand dollars are at their weakest in 2.5 years. While no major milestones were reached in the EUR/USD, GBP/USD or USD/JPY, these 3 currencies still experienced big moves this week.  By now, everyone knows that the rally in the dollar and U.S. yields were caused by Bernanke’s plans to slow bond buying this year and end asset purchases completely by the middle of next year.
Given how the markets have responded, this was a tectonic shift in expectations. With U.S. yields soaring, investors and traders around the world rushed to reverse their dollar funded carry trades, a trend that is likely to continue in the coming weeks, albeit at a more moderate pace. The next step would be to initiate long dollar positions, which we expect to occur over the next few weeks.  Previously the majority of market participants had expected the Fed to taper next year with a minority looking for this to occur in December.  Now everyone has to rush to reset their expectations and positions for the strong possibility of Fed action in September, which means the potential for further gains in the dollar.
In terms of levels, there is a significant support level in the EUR/USD at 1.3075, where the 38.2% Fibonacci retracement of the July 2012 to January 2013 rally converge with the 50,100 and 200-day SMAs.  If this level is broken, the EUR/USD should tumble to 1.3000 but we do not expect significant losses beyond 1.2925 because European data is improving.  The same is true for the GBP/USD, there is support at 1.54 and below that at 1.52. USD/JPY on the other hand is headed for 100 in our opinion but a move to 103 would require Japanese investors finally investing in foreign bonds.  The sell-off in AUD/USD this week stopped right at the 38.2% Fibonacci support of the 2008 to 2011 rally that took the currency pair from 60 cents to 1.10.  For the time being, this level is holding but if it breaks, then AUD/USD could tumble quickly to 90 cents.
EUR – Hit by Weaker Data and Political Troubles in Greece
The euro fell sharply today against the U.S. dollar and is close to giving up nearly all of the gains that it incurred this month.  Weaker than expected economic data, political trouble in Greece and the persistent rise in the U.S. dollar have contributed to sell-off in the currency.  While the euro was one of the day’s biggest losers, its overall decline is still modest compared to the AUD and NZD.  There are bright spots in the Eurozone economy but we need to see more evidence, which will hopefully come next week with the release of the German IFO, unemployment and retail sales reports.  This morning’s Eurozone current account number on the other hand was disappointing with the region’s surplus shrinking to 19.5B from 25.9B.  This wasn’t a major surprise though considering that Germany also reported weaker results for the month of April.  In Greece, the country’s small Democratic Left Party threatened to pull out of the ruling coalition, destabilizing the country’s political outlook.  The IMF also threatened to suspend aid to Greece at the end of June if Eurozone leaders do not close the financing gap in the Greek aid program.  Unfortunately Eurozone Finance Ministers avoided addressing the issue at their meeting on Thursday.  Looking ahead, while the euro could be vulnerable to additional losses against the U.S. dollar, we expect its outperformance against other currencies to resume.  According to the latest CFTC data, speculators turned net long euros after being net short since mid May.
GBP – Loses its Grip, Extends Lower
Today’s sell-off in GBP/USD could be a catch up move after yesterday’s resilient performance but we still expect the losses to be limited because compared to other global economies, the U.K. is on firmer footing. The UK’s public financing needs was less than expected in May. Public borrowing remained high over the past year and the data showed total public net debt rising to record levels in May. A report by the Office for National Statistics revealed that net borrowing excluding temporary support for banks was 12.7 billion pounds compared with 15.6 billion pounds the previous year. The data suggests that the government is on track to meet its targeted budget this year. The report comes as Chancellor of the Exchequer George Osborne prepares to outline 11.5 billion pounds of cuts to the government departmental budget for the 2015-16 fiscal year after weak growth forced him to extend his austerity program. Prime Minister David Cameron’s spokesman, Jean-Christophe Gray, said, “Today’s data demonstrate that the government is getting a grip on public spending. It shows the deficit-reduction plan is working. Obviously that needs to be stuck at. That’s exactly what this government is doing.” First quarter current numbers and revisions to Q1 GDP are the only noteworthy U.K. economic reports on the calendar next week.
CAD – Hit Hard by Disappointing Retail Sales
The Canadian and New Zealand dollar extended their losses against the greenback while the Australian dollar licked its wounds and trickled higher.  Inflation in Canada increased less than expected in May due to a drop in transportation costs that offset the rise in gas prices. Retail sales in April also increased less than expected raising speculation that the expansion in growth could be slowing. Statistics Canada revealed that CPI rose 0.7% in May year-over-year and 0.2% month-over-month. According to the report, “shelter and food components were the main upward contributors to the rise in CPI, while the transportation component was the main downward contributor.” Despite significant improvements in the labor market, Canadian retail sales grew only 0.1% in April and excluding autos consumption fell 0.3%. Bank of Canada Governor Stephen Poloz said that the economic recovery requires “stability and patience.” The BoC sets its interest rates to keep inflation contained between 1% and 3%. These weaker reports will keep monetary policy steady and limit the optimism of Bank of Canada Governor Poloz. Canadian GDP numbers are scheduled for release next week along with New Zealand trade figures.
JPY – No Major Concerns within the BoJ
The Japanese Yen ended the day lower against the U.S. dollar and mixed against other major currencies.  Bank of Japan Governor Haruhiko Kuroda spoke last night and warned that uncertainty surrounding Japan’s economy remains high. Although he stressed that the markets will stabilize over time, reflecting expansion in its economy. Kuroda said, “Japan’s economy is likely to resume a moderate recovery as overseas growth picks up moderately and domestic demand remains resilient due to the effect of monetary easing and various stimulus measures. We will make policy arrangements as needed, examining both upside and downside risks to the economy and prices.” These comments suggest that there is very little motivation within the central bank to take steps to calm the volatility in Japanese markets. Prime Minister Shinzo Abe is also assembling fiscal and monetary stimulus to lift the economy from its decade-long deflation era. In April the BoJ caught the market off guard when it pledged to pump in $1.4 trillion into the economy in less than two years to achieve its 2% inflation target. Japanese government bonds rose to one-month highs with 20-year rose to 1.760% and 30-year rose to 1.880%, however, Vice Finance Minister Shunichi Yamaguchi said in Parliament that Japanese long-term interest rates are not necessarily spiking when viewed from a long-term standpoint. Yamaguchi also said that he trusts that the BOJ will react properly to any bond market volatility with flexible market operations.

IFO OK But EURUSD Capped on Fears About China

By Boris Schlossberg
Market Drivers June 24, 2013
Worries about liquidity in China send Asian stocks lower, AUDUSD tests 9150
IFO basically in line creating minor selloff in EURUSD
Nikkei -1.28% Europe – 1.12%
Oil $93/bbl
Gold $1280/oz.
Europe and Asia:
EUR German IFO – Business Climate 105.9 vs. 105.9
EUR German IFO – Current Assessment 109.4 vs. 109.6
EUR German IFO – Expectations 102.5 vs. 102
North America:
Chicago Fed National Activity Index
Asian markets were destroyed on the first trading day of the week with Shanghai index particularly hard hit as it dropped by -5.3% as investors continue to worry that Chinese policy makers will maintain their hawkish bias on monetary policy tightening credit supply further. Short term interbank lending rates in China have surged as the government continues to appear non plussed by the liquidity tightening.
The rise in risk aversion during the Asian session took its toll on AUD/USD once again with pair making fresh lows as it tested the 9150 barrier. The one way trade in Aussie continues with the shorts now eyeing the psychologically key .9000 level – and if the selloff in Chinese assets continues as the the week proceeds – that target may be reached within the next several days.
The economic slowdown in China is now acting as the key counterpoint to the improvement in US economy activity and the imbalance in growth between the two worlds biggest economies is likely to become the key market theme as the summer proceeds. It is simply impossible to imagine sustained global growth with US acting as the solo locomotive for demand. Therefore this divergence in performance between the world biggest economies is likely to cause more panic amongst investors, accelerating risk aversion flows unless some improvement is seen.
The goldilocks scenario for global growth would entail a soft landing in China, a quickening recovery in Europe and an acceleration of activity in US. But such a bullish outcome is clearly being doubted by the market and if US begins to falter as the summer proceeds risk assets will come under enormous pressure as investors pare back their bets.
The threat of China slowdown was even evident in the EUR/USD trade today. The IFO sentiment survey was generally in line with expectations, with the forward component even beating consensus by a bit. But EUR/USD failed to rally off the news, as investors remain concerned about German exports to China. With exports the key driver of growth in the economy, market participants are greatly concerned that German recovery could sputter badly if demand from China begins to collapse. The pair made a half hearted attempt to rally through 1.3125, but has met selling at those levels throughout the morning European dealing session.
In North America today the calendar is barren and equity markets may see some selling pressure on the open as traders digest the overnight activity in Asia. The EUR/USD remains under pressure and any further selloff could create a test of the 1.3050 level as the day proceeds. However, if there little follow through to the selloff in Shanghai, the pair could stabilize and try to stage a short covering rally towards 1.3150 as consolidation continues.

FX Traders Should Watch Bonds – Ground Zero for Deleveraging

By Kathy Lien
The U.S. dollar is starting the week stronger against all of the major currencies as deleveraging in the equity, bond and currency markets continue to drive investors into the arms of greenback. The rush to liquidate out of dollar funded carry trades along with renewed demand for long U.S. dollar positions has driven the mighty buck sharply higher over the past week. The recent signals of policy actions or lack thereof by the U.S. and Chinese central bank wrecked havoc on the financial markets. Even though the Federal Reserve may feel that the economy is ready for less stimulus investors are worried that fewer asset purchases in the U.S. and less liquidity in China will slow the global recovery. Despite the pullback in the SHIBOR rate, the 5.29% decline in the Shanghai Composite index overnight dragged global equities lower with U.S. stock futures pointing to a sharply weaker open. Unfortunately there are no U.S. economic reports on the calendar today to reverse the slide in stocks.
Forex traders and traders of all asset classes in general should keep a close eye on the bond market because it is ground zero for deleveraging. U.S. 10 year bond yields have broken above 2.6% today, rising another 11bp to its highest level since August 2011. With 3% yield in view, the cost of borrowing could soon reach levels that are overly oppressive for U.S. consumers and businesses. Unfortunately yields in the U.S. are not the only ones that have shot higher this morning. In Australia, 10 year bond yields jumped 27bp, in the U.K. they are up 14bp and Germany they increased 11bp. In a growing economy when risk appetite is healthy, rising bond yields could represent strength but in today’s market environment the rise in yields represent panic.
In recent years, the Federal Reserve’s ultra loose monetary policy kept a lid on yields and made U.S. dollar funded carry trades extremely attractive to global investors. However that all changed last week when Bernanke said the Fed is ready to taper asset purchases this year and end them completely by the middle of 2014. U.S. bond yields soared, stocks plummeted and the dollar shot higher. Last week marked a turning point for the greenback and the uptrend is likely to continue in the coming weeks, albeit at a more moderate pace. The next step of the cycle would be to initiate long dollar positions, which we expect to occur over the next few weeks. Previously the majority of market participants had expected the Fed to taper next year with a minority looking for this to occur in December. Now everyone has to rush to reset their expectations and position for the strong possibility of Fed action in September, leading to the potential for further gains in the dollar.
In terms of technical levels, there is a significant support level in the EUR/USD at 1.3075, where the 38.2% Fibonacci retracement of the July 2012 to January 2013 rally converge with the 50,100 and 200-day SMAs (the currency pair is testing that level as we speak). If this level is broken in a meaningful way, the next target for the EUR/USD will be 1.30. USD/JPY on the other hand is crawling towards 100 but a move to 103 would require the Japanese to buy foreign bonds. The sell-off in AUD/USD is once again stalling at 0.9165, the 38.2% Fibonacci support of the 2008 to 2011 rally that took the currency pair from 60 cents to 1.10. If this level breaks in a meaningful way, AUD/USD could tumble quickly to 90 cents.