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Carry Trade System Anyone ?
Posted: Mon Apr 14, 2008 9:27 am
On Leonardos Infinite Yield Forex site http://www.infiniteyield.com
he mentiones Carry Trades..
I shelved the idea of carry trades a few months ago as implausible (i.e. too good to be true) and I was too busy getting my first fledgling LTTF running.
Leonardo's site (He has carry trades as Unique Edge #1) has made me curious again, despite some on this forum saying they are pointless.
Not knowing much about Forex, I've looked at OANDA (recommended on this forum) & can currently see a ~4% differential between interest in Â£/Yen, with leverage of 20/1.
Is anyone running a Carry Trade System successfully ? Presumably a systematic approach to cater for the differences in the rates over time has to be built, otherwise the interest profit can be wiped out by the movements ?
Posted: Mon Apr 14, 2008 9:54 am
I'm currently working on a forex carry system.
Posted: Mon Apr 14, 2008 10:19 am
Posted: Mon Apr 14, 2008 10:29 am
Try buying and holding the DBV. It's an ETF that approximates the value gained by a 3-long, 3-short "carry trade" taking place on the G10 currency set.
Whether you like the idea of buying DBV or not, I would highly recommend reading their prospectus and other material as "educational" re: carry trade.
Posted: Mon Apr 14, 2008 2:31 pm
Just some info on carry trades:
- There is a lot of literature out there. If you are interested in more academic studies look for UIP (uncovered interest rate parity) for FRB (forward rate bias).
If you are looking at futures within TBB you need to be able to get to the interest rate in order to rank the various currencies or at least know what is at a premium or discount vs spot. Depends on your trading algorithm. In the DB Harvest Index they rank in other papers people just go long/short depending on the forward vs spot differential.
Recently most carry strategies have been getting killed. They have been money machines over the previous 3-4 years but in the least few months (credit crisis) they have not done too well. Just know your beast and some of the "Peso problem" arguments people put forth against this type of strategy.
On the other hand great time to research this area since it is now out of favor and will come back as the
trading style (vs momentum which is now king) in a year or two.
Posted: Tue Apr 15, 2008 12:57 am
On the other hand great time to research this area since it is now out of favor and will come back as the trading style (vs momentum which is now king) in a year or two.
Momentum is still a vital element in carry trades surely?
If currencies did not move in relation to each other or were endlessly bound within a tight range, all you would have to do is sit around and collect the interest rate differential.
And yet, as I understand it, much of a trader's profit in this game actually comes from momentum, as the higher yielding currency is bid up against the lower yielding currency. So during the long decline of the Yen versus the US Dollar, the carry trader's position would have been the same as that of the momentun following trend trader.
Posted: Tue Apr 15, 2008 2:23 am
Interesting & encouraging stuff, and certainly worth some exploration.
DB Funds state:
Seeks to track the Deutsche Bank G10 Currency Future Harvest Indexâ„¢ by (1) entering into long futures contracts on the three G10 currencies associated with the highest interest rates, (2) entering into short futures contracts on the three G10 currencies associated with the lowest interest rates, and (3) collateralizing the futures contracts with United States 3-month Treasury bills.
Doesn't look quite like a carry as I understand it - just betting the High Rate Ccy rises & the Low Rate Ccy falls. Don't see where the interest differential comes in. Still, their equity curve is fairly smooth
Posted: Tue Apr 15, 2008 5:44 am
I was under the impression that the difference between the futures contract price, and the actual spot exchange rate, was determined by the interest rate paid by short-term bonds in the subject currency - similar to how the contract price on the index contracts differs from the cash price in part due to dividends.
Posted: Tue Apr 15, 2008 6:44 am
Like I said...
Not knowing much about Forex...
Thanks nodoodahs, thats helpful & makes sense - never even considered there was something to consider here !
Posted: Tue Apr 15, 2008 9:37 am
AFJ - yes momentum (trend) is part of the return of the carry trade strategy but not the signaling mechanism. In general I think about 50% of the returns to the various indexes come from the trend part vs the interest rate differential. Your millage may vary based on how you construct the carry trade etc. DB in their Harvest index may have this statistic - don't recall.
With that said there are times trend/momentum trading is close to 100% opposite of the carry trade - just look at the JPYUSD over the last few months etc. This can also be seen in the fund returns. Most trend traders in FX made good money in Q1 (> 10%) while most carry traders lost ( -10% or more). Looking at statistics for the Yen in a carry trade over the last 10 yrs, 0% of the months were spent long yen while 100% of the time were spent short yen. Looking at a trend strategy about 40% was spent short yen (this time is in sync w/carry) but the other 60% was spent evenly between neutral or long positions (opposite the carry signal).
As mentioned with futures the interest rate differential is built into the futures price. The strategy is quite simple when implemented this way and no big secret:
* compare futures price to spot price
* if futures < spot then buy the futures contract (as futures reaches delivery date it should converge to spot, e.g. increase in value)
* if futures > spot then sell futures contract
* perform this every quarter 1-2 weeks before delivery
This very simple strategy using IMM based futures has been shown to generate positive returns on average since it was first published in the 1980s... You'll need to decide for yourself if the various risk statistics, flat periods etc are right for you and your trading style.
Posted: Tue Apr 15, 2008 11:38 am
svquant wrote:Looking at statistics for the Yen in a carry trade over the last 10 yrs, 0% of the months were spent long yen while 100% of the time were spent short yen. Looking at a trend strategy about 40% was spent short yen (this time is in sync w/carry) but the other 60% was spent evenly between neutral or long positions (opposite the carry signal).
I see, thanks. I had not appreciated that a carry trade simply continued for as long as the interest rate differential was there, come hell or high water. I had assumed that some sort of entry and exit criteria was used.
Posted: Tue Apr 15, 2008 1:50 pm
Clarification - the statistics I gave were from a top/bottom 3 type of system for both momentum & carry trades. The carry trade strategy is very close to the G10 Harvest Index from DB: long 3 highest interest rate currencies, short the three lowest interest rate currencies. Since Japan's IR has been ~0% for most of the decade it is easily in the bottom 3 every month or quarter - thus always a sell. But there is a chance for a neutral position in this strategy.
The spot vs futures price system I mentioned is a different strategy that has been published and is based on the carry trade. It is a SAR-type system.
Adding different exit and entry signals other than the simple ones mentioned is left as a (fun) exercise to the reader...
Posted: Tue Apr 15, 2008 4:47 pm
For those of you looking at the carry trade for the first time:
1) Calculate the interest rate differential between a currency pair.
2) Convert the extra interest you would earn in one day on the carry trade, to "pips" in the associated currency.
3) Compare one day's extra interest in "pips" to the daily "pips" volatility of the currency pair.
I believe you will find that the daily volatility in a currency pair far overshadows the daily interest on the carry trade. For anyone one that has attempted a carry trade on OANDA, they will know that a carry trade offers no real edge, in my opinion.
Posted: Wed Apr 16, 2008 7:45 am
Daily vol ... over what timeframe? The last six months? The six months that occurred 5 years ago today? The last 12 years? The last 12 days? The 25 days preceding June 15th?
I think you will find that there are months at a time when daily interest gains are higher than daily volatility of the underlying, and that there are months at a time when the reverse is true. Hmmm ... just like you'll find that there are months at a time when commodity markets seem "trendless" and months when several markets are in smooth trends!
Over LLLLOOOONNNNGGG periods of time, the trade as proxied by the DBV will yield decent stock-index-like returns, but in an uncorrelated return stream.
Over SHORT periods of time, it may have correlation to the stock market and may underperform - see recent months for an example.
The key to high-return execution when it's used as a star in one's stable of systems is increasing leverage when volatility is low, and decreasing leverage (or exiting the trade) when volatility is high (relative to interest gains).
Relatively unlevered, it's a decent diversifying system other than the main system.
I don't know if OANDA is the best place to try executing the trade.