Long Term Carry Trade Fundamentals

While reading a recent CNBC article about current events something clicked for me.

Here is the passage:

The dollar rose broadly on Thursday as yields on 10-year U.S. government bonds jumped more than 50 basis points in the last two weeks, drawing Japanese investors into overseas assets like global semi-conductor stocks, banks and U.S. junk bonds, according to Reuters.

Do you remember the massive unwinds that occurred during the past year? Do you remember all the talk about money heading towards Japan due to risk aversion?

Pay attention, this is significant. It's also backs up my much touted long term notion that carry trade currency pairs are in for a recovery.

Given the quote above what do you think will happen once the jobs numbers start to turn around in the US economy? I'll tell you what I think. I think interest rates and yields will start to rise. What do you think all that money sitting in Japan will do if there is a hot US economy paying good yields? I suspect that it will leave Japan in order to earn good returns.

Guess what that will do to the Yen? That's right, it will drop like a stone. When that happens you'll see carry trading pairs rise massively.

Okay, I realize this may be a year to two away, but as long as we do eventually get a worldwide economic stabilization this is what is in store for us. Anyway, if you are a rookie, be careful, as you can't simply make long term bets willy-nilly. The market can always move against future expectations long enough to blow up your account and it often does so as soon as you throw caution to the wind.

What this means for me is that I may be more willing to accumulate carry trade positions at moments of opportunity. Keep an eye out for fundamentals and watch leading economic indicators such as the Baltic Dry Index or the price of copper.

As you can see these indexes are rising. However, they are still at historically low levels. Are we just in a bounce with respect to worldwide economic activity or are we simply coming up from a recent bottom? You decide.

Twitter Forex Tweet Strategy

Have you been following people involved in fx trading on twitter?

Have you noticed how many people are happy to tell you what happened? While macroeconomic news and previous day post analysis can be useful, it certainly doesn't help you make a trading decision based on current charts.

I have a little proposal to make.

Instead of tweeting that you've opened a long or short position provide some information that other people can use to apply their own strategies. Frankly, I don't care what crappy decisions others are making. I care what the charts are saying. I'll do my own technical analysis and decide on my own trades.

So, tell me that a pattern is forming on a named pair's chart in a certain timeframe. For example, right now the AUDJPY is retesting May highs of 76.00 and obviously this is true on any chart -- though you may need a longer chart to actually see it.

Then, I can whip open my chart, draw some lines, figure out a strategy, and trade on the opportunity.

To summarize, we need to tweet about opportunities that are shaping up. We need to just drop each other a note that something is happening. Anybody who has traded for any length of time can figure out what to do -- but unless we have the luxury of trading full time we just can't spot all the opportunities.

In short. Smarten up and stop trying to show the world how damned smart you are. We don't care!

How about we call this the Useful Forex Tweet Agreement (UFTA).

UPDATE: I've tweeted the AUDJPY information (again) using the #ufta tag...

Forex Tips - Microtrading

The AUDJPY currency pair is currently trading around the 76.00 mark.

Over the last twenty days, from May 7 through May 27, I've been experimenting with a concept I've been calling microtrading.

I don't intend to close all of my positions at the moment, but if I did my account NAV would increase by more than 10% over that period.

While I realize that active trading can return spectacular results compared to a paltry 10% it does require a lot more effort and time. Personally, my full time job and other issues have my complete attention. I don't have the luxury of time or the mindset to take larger risks at the moment.

Anyway, open up your trading platform and I'll walk you through the process of trading this strategy.

1) On May 10 we topped out around 76.00 on the AUDJPY pair.

2) Based on my account size I could safely open long positions for every fall of 20 pips. This isn't the goal but it is the maximum density of trades I'd allow.

3) As the price of this currency pair dropped to around 70.50 on May 15 I would accumulate positions based on the previous point. Basically, when you see what looks like a support point or if the price moved down a lot while you were at work or sleeping, then you open another micro trade.

4) When any one trade has more than 200% profit with respect to margin committed and you believe you are at a resistance point, consider unloading it.

5) Be patient when the market moves sideways. In terms of serious monetary strategies a week or a month is not a long period of time. Keep in mind that you are trading a carry trade pair so you will be paid to wait.

6) I firmly believe that eventually the AUDJPY pair will recover strongly. I'm willing to hold positions for long periods of time as I wait for this. If you don't believe this or you aren't willing to wait, then this strategy may not be useful for you.

Using the above method, with almost zero stress except for impatience during several weeks of sluggish movements, my trading account never committed more than 6% of it's NAV (using 50:1 leverage which is the maximum at my fx broker -- Oanda). However, this morning, as I've stated above, I could close out all my positions at a 10% NAV gain.

This is a simple trading system, though purists may balk at calling it a "system" due to its loose definition. Wait for a drop and buy tiny positions. Capture large profits when they present themselves. Be patient and don't accumulate too large a portion of your NAV. I'd definitely recommend using Oanda due to the ability to trade any size positions and the fact that you can't trade with extreme leverage.

FX Trading And Analysis

I've become a little frustrated with most of news sources out there. If you've been an active forex trader for any length of time you'll notice that talking heads are always trying to tell you why something happened.

That's really nice, and might possibly help you learn about various financial interactions, but it's absolutely useless from a trading point of view. If you are trading you need to figure out what's going to happen -- not what just happened. Check out this video (complete with atrociously low audio levels).

This type of analysis is unlikely to help you with your fx trading tomorrow. Generally, how the markets will move tomorrow, based on tomorrow's news, is not something you'll get from any of the gurus and talking heads.

On the other hand useful analysis will be too slow to be meaningful. For example, I'm very confident the world economy will eventually recover. When that happens we'll have a period of high interest rates as rising commodity prices drive inflation. Guess what? This will mean that carry trades pairs will end up at much higher prices. Unfortunately, I can't tell you when the world is going to focus on this. Generally, not before the money moves from wherever it is to wherever it is finally going to end up.

The closest thing to predictive analysis, or something you can really use to drive your forex trades, is technical analysis. Charting. Something which gets very little respect in some circles. Many people don't understand it and many others discount it because it isn't able to make perfectly accurate predictions. Technical analysis does not have to be a perfect tool for prediction. It merely has to increase the odds that your fx positions end up earning you a profit.

Microtrading: Decent Returns?

I blogged about this idea not too long ago. The concept is to use very small trades relative to your available margin and net asset value (NAV). I'm doing this with the AUDJPY pair so that when I accumulate positions I am earning a positive carry trade return.

My trade size over the last week has been such that the margin involved in each trade is 0.2% of my NAV. That's tiny. Twenty five trades in and you are looking at using 5% of your available margin.

However, the carry trade interest would represent approximately a 3.65% return if annualized. At the same time my unrealized profits had me up almost 4% earlier this morning. This 4% unrealized profit is due to only the last 10 days of trading. We've had a downturn, I've accumulated positions, and the AUDJPY has jumped just recently.

Anyway, I hope this demonstrates that short term scalping is not the only way to earn money using forex. While this concept won't make you rich overnight the risk is very low and the returns can be good compared to currently available financial instruments.

Theory: Trading With Little To No Margin

As I often do, especially when the markets are excruciatingly slow in determining when to make the next significant move, I've been thinking about Forex.

Take a mental walk with me...

The DOW falls from 10,000 to 5,0000 and loses 50% of it's value. It returns from 5,000 to 10,000 and gains 100% of it's value.

Wait, think about that for a minute. In the normal world having the ability to gain double digit gains, per year, is considered excellent.

If you are confident that an upward cycle will eventually happen, in a suitable time frame of course, then movement is valuable. If you aren't trading on margin, and you don't have the associated risk, then you can afford to look at each dip in price as an opportunity.

While this may be applicable to the DOW, it is ever more applicable to the Forex markets. If you are trading with little or no margin it's simply a matter of scaling your entry and exit based on price moves. This is very similar to the gridding concept that I posted recently.

However, when the margin is gone the risk is gone. You choose the price range you expect and scale your entry and exit points within it. If you must, you leave some positions in place while you recapitalize to attack another range. In fact, perhaps you simply allocate a set number of dollars per thousand pip trading range. If the price falls into a lower range you simple ante up and play within a lower range -- while your higher range positions provide interest income.

However, keep in mind, it's possible that currency pairs adjust interest rate differential. This could erode or reverse the suitability of holding a pair over a long period of time.

MT4 EA: Average Position Based Trading

While I don't have any pictures to show, yet, I am working on an EA that trades AUDJPY based on the market price relative to the average price of positions held.

The first few passes at this type of system were pitiful. My testing starts from September of last year to now while only opening long positions. As you can imagine this is a difficult period of time for a long only system!

However, late last night I was able to complete a test that showed profits.

The strategy behind this EA is basically as follows:

• If you've just seen a recent downward movement open an initial position.
• If the price is high enough above or below your average order open price, open another.
• If the current price is above your average price close your lowest and most profitable position.
• Try not to open any position while in a downward movement regardless of the above rules.

Obviously, the last item mentioned is not simple, but it is the key to account survival. If you open too many positions and the market falls too far you will get a margin call.

As ever, I'm basically using the AUDJPY for this. I am interested in strategies that can accumulate a safe quantity of long positions such that they pay me to wait for the eventual upturn.

I'll provide updates once/if I'm able to get appropriate results.

... continuing ...

Here's a chart showing this:


Notice the wicked looking draw down during challenging periods of AUDJPY decline?

Theory: Gridding Microtrades

I've been thinking about grid based strategies designed to take advantage of volatility without incurring great risk.

The idea is that the strategy be followed using a carry trade pair in the event that you do inevitably end up holding some positions. You'll want a platform with a decent spread. Oanda often has about a 3.0 pip spread on the AUDJPY pair -- my current pair of choice.

So, let's start with these parameters:

• Every 20 pips have a limit order with a take profit of 20 pips.
• Each order is for 125 units (not lots).

What does this mean? It means that we will earn approximately a penny per pip of movement. It also means that a sustained downturn will accumulate positions at a very slow rate.

Note: I'll be throwing around numbers very loosely, if you want to consider this type of strategy seriously you'll want to account for spreads and other issues very accurately.

However, as I'm sure you can imagine, not all currency moves are for 23 pips or more. There are a lot of small moves that would be contained within a 20 pip range. There are a lot of moves that would rise and fall above the purchase price without being sold for a profit. This is missed opportunity.

You can easily calculate your risk... just assume a straight fall to some absolute low with a position acquired every N pips. Don't forget to account for the losses as purchases at higher levels will be suffering losses as well. How much capital do you need to sustain all of that?

What if you placed limit orders every ten pips and maintained a 20 point take profit stance? You'd double the theoretical maximum at risk and earn 2 cents per pip (over larger distances) if you kept the position sizes the same. It get's interesting when you decrease the size of the positions to reduce risk. Once you do that you can increase the density of your positions.

The interesting question is how much movement can you profit from as you increase position density, to catch smaller moves, given the spread on the pair you are trading? How many pips can you catch in a day without being in danger of accumulating more than you can handle in a downturn?

Practical risk reduction steps could be taken...

• You could place limit orders above the current price to avoid buying positions on the way down.
• You might also decide to trade only during periods that certain conditions are met.
• You might stop trading if you accumulated a large net position
• You should eventually make some profits which has the result of increasing your capital and adding to your total risk capacity.

This again gets interesting. If you assume you stop accumulating positions at a safe point you could easily recapitalize your account to start trading again within a lower range. While you trade with this new capital, within safe limits, you'll have a carry trade position which should have a reasonable average price in the bigger picture measured in months and years.