Global Forex Trading Questions – Part 4 of 4…

What is carry? The most common and popular trade in currency exchange, practiced by the largest of hedge funds as well as the smallest of retail speculators is the carry. The fact that each and every world currency is attached to an interest rate is the premise on which carry trade rests. These interest rates (short-term) are set by these countries’ central banks:  the US’ Federal Reserve, Japan’s Bank of Japan, the UK’s Bank of England.

The carry is really quite straightforward. A trader goes long on the currency showing a high interest rate then finances that purchase using a currency showing a low interest rate. Back in 2005, the NZD/JPY was seen as an ideal pairing for the cross. The New Zealand local economy, had been spurred by huge commodity demand from China, had a hot housing market, and saw rates rise to 7.25% and remain there), while Japanese rates remained at 0%. Going long on the NZD/JPY would have harvested an astounding 725 basis points just in yield alone. Based on 10:1 leverage, the carry trade for NZD/JPY would have produced 72.5% annual return just from the interest rate differentials without any contribution from capital appreciation. Can you understand now why carry trade is such a popular choice? Beware of high-yield pairs for when carry trade unwinds, declines may be both rapid and severe, known as carry trade liquidation that occurs when a majority of speculators decide the carry trade might not contain any future potential. If every trader seeks to exit their position at once, the bids disappear and profits from the interest rate differentials no longer are enough to offset capital losses. Not surprisingly, anticipation, as usual is the key to success: with positioning a carry for best results at the start of a rate-tightening cycle, thus allowing a trader to ride a move as the interest rate differentials increase.

Jargon used in FX…

Each discipline uses its own jargon as shorthand and the currency exchange market is no different. The following terms are handy to know when global forex trading…

• GBP: British Pound, Sterling, Cable, Pound
• USD: US Dollar, Greenback, Buck
• Swiss Franc: Swissie
• AUD: Australian Dollar, Aussie
• NZD: New Zealand Dollar, Kiwi
• CAD: Canadian Dollar, Loonie, the little dollar