Currency Carry Trade of The Year: Short The US Dollar

Despite the widespread turmoil and confusion in financial markets, shorting the US Dollar prevails as the best currency carry trade for 2009.

Before discussing the various ways to take advantage of this trade, let us first discuss the carry trade definition.

Executing a carry trade is the practice of borrowing in the currency of a first country where interest rates are low and lending the proceeds in the currency of a second country where the interest rates are higher, in hopes of profiting from the difference.

Currency Carry Trade Example
A simple carry trade example is when a person receives a loan from a US based bank for $10,000 in US Dollars at the low loan interest rate of 1% and uses that $10,000 to open a savings account in a country like Australia which has a higher annual percentage rate of 5.5% for savings accounts.  The savings account is denominated in Australian Dollars.

This allows the US borrower to earn a carry trade interest rate of 5.5% – 1% = 4.5% on his debt (as opposed to paying 1% if he had not opened the Australian savings account).

The only carry trade risk is caused by the possible decline in the value of the Australian currency when compared to the US Dollar.  However, in current market conditions, this risk is mitigated by the US Dollar’s weakness year-to-date.

Top carry trades for 2009

Hungarian Forint
Symbol: USD/HUF
Direction: Short
Carry Interest: 7.7% APR
Year-to-Date Currency Gain: -0.36%

Turkish Lira
Symbol: USD/TRY
Direction: Short
Carry Interest: 7.2 APR
Year-to-Date Currency Gain: 2.72%

South African Rand
Symbol: USD/ZAR
Direction: Short
Carry Interest: 5.2% APR
Year-to-Date Currency Gain: 15.86%

Mexican Peso
Symbol: USD/MXN
Direction: Short
Carry Interest: 3.2% APR
Year-to-Date Currency Gain: 5.94%

Australian Dollar
Symbol: AUD/USD
Direction: Long
Carry Interest: 2.05% APR
Year-to-Date Currency Gain: 19.14%

New Zealand Dollar
Symbol: NZD/USD
Direction: Long
Carry Interest: 1.2% APR
Year-to-Date Currency Gain: 16.70%

Note: Currency Gain does not include carry interest earned.  Carry Interest APR and YTD Currency Gain are based on data as of 08/18/09 provided by Oanda.com.

My personal favorite carry trades are the Australian Dollar, the New Zealand Dollar, and the South African Rand trades (in that order).  These are my favorites because the underlying fundamentals support this trend’s direction more so than the other carry trades.  This support is easily visible in the year-to-date gains in the underlying currency’s value.

The forex carry trade is a pretty passive way to earn a high interest rate in currency markets, especially if you are already a trader.  However looking forward, entry into new carry trades at this point in the year and economic cycle should be done cautiously with careful consideration of future changes in economic conditions, interest rates and market sentiment.

Dual Screen Bloomberg Terminal

I’m not using a Bloomberg, but I do run a triple screen setup which is perfect for my needs.

(Image Source: Flickr user Mr_Flash)

Separated at Birth: Investing, Saving, Trading and Gambling

While some people may get investing, saving, trading and gambling confused with each other, there are some distinctions that separate these not too distant cousins.

Most of the confusion revolves around the fact that most people never really consider the objective for participating in each of these activities.

Investing
According to Wordnet, investing is defined as

laying out money or capital in an enterprise with the expectation of profit.

When compared to saving, trading and gambling, investing is distinct because when a person or enterprise invests, there is a reasonable expectation of profit.  Additionally, while more similar to saving and trading all investing activities have an inherent amount of risk.  However, the likelihood of the investor losing all of their money or capital is minimal, because money or capital is allocated to assets which usually have an intrinsic value.

Saving
Saving is the activity of protecting something from loss or danger.  When it comes to finance the “something” that your are protecting from loss is your hard earned money.

In simple terms, saving is delayed spending.  Most often, saving money is done in anticipation of future purchases and/or unforeseen expenses.

Saving is distinct from investing because there is no expectation of profit from your savings.  However, in today’s advanced financial markets, institutions reward individuals for saving by offering the ability to earn interest on their savings while knowing that their funds are insured against loss by the Federal Deposit Insurance Corporation (FDIC).

Saving is far from trading and no where near gambling.

Trading
Trading is defined by Wikipedia as

the buying and selling of financial instruments such as stocks, bonds, and derivatives.

Trading like investing comes with the expectation of profit, however the two are distinct in that traders 1) usually specialize exclusively in financial instruments and 2) have a shorter time horizon for realizing their expected profit.  In a sense a trader can be viewed as a short term investor.

One major distinction between investing and trading is the use of gearing or leverage when purchasing the various financial instruments.  Leverage allows the trader to use other institution’s monies and capital to buy financial instruments and as a result it multiplies the trader’s gains and losses.  Therefore, the trader must use proper risk and money management in order to decrease the probability of losing all trading capital due to the leverage’s multiplying effect.

Trading is closely related to investing, is not very related to saving and is a gamble.  In my personal opinion, trading is a gamble only because of the potential to lose all trading monies if risk and money is not properly managed.  The same amount of risk is not found when investing due to the minimal amount of leverage used on average.  Additionally, the minimal reliance on chance and the uncertainty separate it from gambling.

(Note from the Devil’s Advocate:  Individuals who play poker for a living are gambling, but it is somewhat biased to consider it a gamble if these individuals can consistently withdraw profit over several years.  Also, several professional gambler’s have stricter risk and money management rules than some of the traders and investors I know.)

Gambling
Gambling is the wagering of money or something of material value on an event with an uncertain outcome with the primary intent of winning additional money and/or material goods.

Due to the heavy dependence on chance and uncertain outcomes, gambling cannot be considered a viable means of investing, saving or trading.

Now that we have gone through four topics that have caused many heated discussions over the years, hopefully you are better prepared to discuss these topics at the next outing you attend.  If not, you can always just tell the other person that they know nothing about anything and put your fingers in your ears.

Also, share this with someone you think would like the information and share it ten times with someone you think would hate it.

(Image Source: Flickr user Juju Inspired)

The Hard Working Dollar Weekly Roundup 08/09/09 – 08/15/09

This past week was a pretty slow one as far as posts, news and capital markets go.  My view is that despite the fact that summer is about  a month from being over, people are getting more into the fall mindset.

The following articles were published last week (oldest posts first):

1. 5 Ways To Save Money In This Economy
   Over the last year, lots of people have said that saving money in this economy is difficult, if not impossible. However, there are several small things you can do to make it easier for you to save.
2. Hard Working Deals 08/11/09
   Hard Working Deals: A collection of product and travel deals from around the web.
   Highlights:
   DSW.com – $10 off $49 Purchase or Free Shipping
   Home Depot – Clearance Sale: 20% to 50% off Select Items
   $499 — Ireland: 6 nights in B&Bs & castle with air
3. Cutbacks in the Kitchen
   As times have gotten tougher over the last year Americans have been spending less and less on groceries.
4. Subscribe To This Blog
   By subscribing to this web log dedicated to personal finance, investing, trading and frugality you will be provided with daily and weekly content updates that will help your money work harder.

(Image Source: Flickr user Flow Design Studio)

Trade Analysis: Short EUR/CAD 07/14/09

This is the first of several trade analysis that I will be doing on a varied basis with the goal of explaining the logic for my entry, my various exit strategies and discussing the fundamentals of the trade.

Asset: EUR/CAD
Direction: Short
Entry Date: 07/14/09
Analysis:  This trade was entered after the market broke through support to the downside on 07/14/09 at a price of €1.6014 and a stop loss of €1.6494.  The original support level was breached the day before, but I like for my support and resistance trades to move a little beyond their support/resistance levels, so I know the market has conviction about its direction (because we all know the market never maintains its conviction for long).

Prior to the entry the market experienced a period of what I like to call “market noise” from around Jun 26 until around Jul 13.  I liken this “market noise” to a capacitor which is storing energy.  And like a capacitor, when the market releases this energy in one direction or another, the move is usually stronger than normal.  (As evidenced by the strong break through the blue 7-day Bollinger Band which has a 2 standard deviation upper and lower band.)

All my entries on the EUR/CAD are set with a stop loss of a 3% price move against the position entry and the position size is such that a 3% price move against an individual position would result in a 1% loss in my account balance.  Additionally, I attempt to add new positions with every 3% price gain.  If any one position gets stopped out I close all the positions.  (Also because I trade long and short positions in separate accounts, I typically will have partially hedged positions whenever trends are near completion and have broken through support/resistance in the opposite direction.)

I entered the second position at €1.5423 at which point my original position had a gain of 591 pips or 3.83%.  In actuality I was supposed to enter the position at around €1.5534, but because my entry was still within 1% of my target re-entry price, it was still within my trading rules to enter the position.

The final position was entered at €1.5201 which was 1.44% or 222 pips from my second entry.  Entries beyond my second entry are typically spaced 1.5% away from each other, simply because trends don’t last that long and I want to give myself more room to exit within my rules should one of these “final” entries get stopped out.

My non-stop loss based exit strategy will be to wait for some “market noise” to occur and to place my stop loss for all my positions 20-50 pips above the resistance level.

I will also be looking to enter again at €1.4973 with a position size that is about a 75% to 25%  of my current position sizes.  That would make a a 3% loss 0.75% to 0.25% of my account balance.  But at that point I would already have an unrealized gain of about 1000+ pips just on my original entry which would give me an unrealized gain of 6.5%+.

Regarding, the EUR/CAD as a whole, my current view is that when compared to the European Union the Canadian economy is in a much better position and will come out of its current economic slump at a faster pace than the Eurozone.  This opinion is based on the fact that the Canadian economy is more homogeneous in its membership components and is more reliant on export based growth versus the consumption based growth which the Eurozone is much more reliant on.   Also, if one considers the fact that the Eurozone is made up of member nations, you have keep in mind that an economic region is only as strong as its weakest link and the Eurozone has far more “weak links” than the Candian economy could ever have.  Therefore, it is my opinion that short EUR/CAD will be the overwhelming theme for 2009 and that this theme will remain until mid-late 2010.  (I could quote lots of economic numbers comparing the two economic regions, but that is an article for another day.)

Anyway, as this is my first trade analysis article, I am looking forward to your comments regardless of whether they are positive or negative.

Image Source: A.K.

News: Rare Video of Billionaire Paul Tudor Jones Surfaces

Paul Tudor Jones circa 1980s. Notice the message on the wall.

This video is a documentary by PBS which was done in 1987 and is entitled ‘Trader: The Documentary’ (split up into multiple parts).  It follows the daily life of a young Paul Tudor Jones, who is now a billionaire commodity trader.

This video has been extremely hard to find and those possessing a precious copy guard it with their life and/or sell it on eBay for hundreds if not thousands of dollars.

Without further ado I present the video below.

Image Source: Google Image Search

What Is Foreign Currency Trading?

As a side effect of the growth of the Internet and the democratization of information, the once obscure field of foreign currency trading has become available to individuals with little or no previous exposure to capital markets.  However, before pursing this field, one needs to first define foreign currency trading.

Google defines currency trading as follows:

“The act of exchanging the legal tender of one country for another.“

In simpler terms, currency trading is the exchanging of the paper or metal mediums of payment of one country or economic region for the mediums of payment of another country or economic region.  In most situations, currencies are traded between countries and/or economic regions because individual governments aren’t required to accept another country’s currency and often have multiple trading partners outside of their own borders.  Therefore, the need to trade currencies comes out of the desire to trade goods and services with other countries, while maintaining economic independence via your own country’s currency.  Additionally, there are several other reasons for trading currencies which will be discussed below.

Now that we have discussed why countries and economic regions participate in foreign currency trading, we have to discuss where, when, how, who and why of foreign currency trading.

Where Do Foreign Currency Trades Occur?
All foreign currency trades take place on an exchange just like stocks and other capital market assets.  This exchange is called the “foreign exchange” and is the place where currencies are bought and sold for immediate or future delivery.  The foreign exchange is also known as the Forex market (FOReign EXchange = FOREX) and is the largest exchange in the world.  According to the Bank of International Settlements the foreign exchange has an estimated average daily turnover of $3.98 Trillion (and that estimate was as off 2007).

Although most currency trades occur in electronic currency markets, trading currencies also occurs in physical markets.  A great example of physical currency trading is when an individual exchanges their country’s currency for another country’s currency when traveling.

When Does Currency Trading Take Place?
Currency trading takes place at all times.  Unlike stock exchanges, the foreign exchange is open 24 hours a day starting at around 5pm EST Sunday and ending at 5pm EST Friday.  The forex market is also open Saturdays, but prices don’t move much because of the decreased number of market participants.  This 24 hour market cycle is due to the fact that the world, as a whole, is never asleep all at once and therefore one country’s good or service is always being exchanged for another country’s good or service.

How Do You Trade Currencies?
Currencies are traded in pairs.  This is because when a currency trade is made, two transactions actually take place.  One currency is being bought and another currency is being sold.  For example if you were an American traveling to Europe, you would exchange your US Dollars for European Euros, which is the same as selling your US Dollars and buying European Euros.

Who Trades Currencies?
The foreign exchange market is made up of numerous market participants.  The primary categories for market participants are governments, central banks (which are usually extensions of the government), large banks, corporations, currency speculators and other financial institutions.

Why Trade Currencies?
There are two main reasons to trade currencies, 1) to profit from the increase or decrease in value of one currency when compared to another currency or 2) to protect asset holdings in one currency from losing value against another currency.

As a whole, currency trading is a vital cog in the wheels that drive a global economy.  It is especially important considering that our world is heavily dependent on trade between numerous countries and economic regions.  So the next time you read a product label that says “Made in China” or drink a cup of Colombian coffee, consider the fact that a currency trade had to take place in order for you to enjoy that product.

Various Paper Currencies From Around The World

(Image Source: Britannica Student Edition)

The Dow Tops 9,000 for First Time Since January

The Dow has reached the strongest point since January after a more than 2% intraday gain.  Read the rest of the story at Bloomberg.

Image Source: Flickr user Liz_Lomax

Also, I love this picture.

The Federal Reserve’s Plan To Avoid Inflation

Today the Wall Street Journal published an article written by Federal Reserve Chairman Ben Bernanke, which details how the Federal Open Market Committee plans on controlling the amount of inflation experienced once the United States begins its economic recovery.

In my own opinion the most important statement is when Bernanke says the following:

At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road.

My take away from the article is that Bernanke is aware of the fact that inflation will be a major concern in the future due to the amount of money currently in circulation and hopes to control the amount of inflation using monetary policy.  While I cannot say how affective his efforts will be, I am curious to see how the events unfold.  Read the rest of the article at the Wall Street Journal Website.

Image Source: Flickr user  Eric_Landstrom