Macro Trading the Carry Trade
Macro traders trade virtually everything. They trade stocks, bonds, commodities, and currencies looking for uncorrelated trade ideas with great risk to reward characteristics. Sometimes they will even venture into markets like real estate and even art.
You trade not only different asset classes but also different strategies within the different asset classes. Aside from straight directional trading you likely do some relative value trading where you put pairs together and trade on their convergence or divergences. You might try some merger arbitrage, pairs trading, etc. Basically you are looking for great risk to reward opportunities and you don't care where you find them.
One area that is particularly suited to the macro trader is that of the currency markets. Yes, they trade currency crosses and build their own cross baskets but macro funds are also known to trade one strategy called the carry trade quite frequently.
The carry trade consists of going long a high yielding currency and going short a low yielding currency to fund the trade. You make money in two ways. One is if the initial trade is profitable if the higher yielding currency goes up relative to the low yielder. The other way to earn money is to make money off the carry, or the interest rate differential.
Using leverage you can really juice your returns in the carry trade. For instance if you are earning a three percent yield from the differential then you can earn thirty by being levered up ten times. If you lever up twenty times you will earn sixty percent. While these gains sound great they do come with great risk. You knew this couldn't be that easy.
No, it is not that easy. If volatility picks up and the carry trade loses favor then the carry will not be enough to make up for the huge loss in capital on the directional side of the trade. If you use too much leverage you will go kaboom and lose all your money.
There are several ways to measure volatility. Some traders just look at several pairs and use an internal barometer of what is happening but most successful traders use at least some type of quantitative measure. We have the VIX which is used to look at equity volatility but happens to be a decent barometer of all volatility. There are also several newer currency volatility gauges like the JP Morgan currency volatility tools and the other investment banks volatility tools.
If you are global macro trader trading the currency carry trade then you need to be paying attention to volatility or eventually you will lose a lot of money. By focusing on the risk you will be in a far better position for the rewards.
Article Source: FxTradingStock.com
About the Author
If you need actionable trading ideas then check out The Macro Trader It is a weekly global macro trading advisory publication with frequent intra-week updates for time-critical analysis and actionable trading ideas.
by: Ben Summers
Total views: 122
Word Count: 471
Date: Fri, 24 Jul 2009
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