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.
They trade not only different asset classes but multiple strategies within each asset class. For instance in stocks they will trade outright long and short positions, merger arbitrage deals, asset class arbitrage where you trade the equity against debt, and even pairs trading. They do much of the same in commodities and currencies as well. Essentially they are looking for sources of return wherever they can find it.
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.
To make money in the carry trade you go long a high yielding currency and go short a low yielding currency. By doing this you are able to earn the interest rate differential which is simply the difference between the two currencies interest rates. You can also of course earn money by being right on the trade and the direction.
To really juice the returns available from the carry trade you can and probably should use some degree of leverage. Some traders are modest and only use two to four times leverage while others are aggressive and use up to fifty times leverage. While high leverage is great when you are right they can be disaster when you are wrong as the losses are magnified on the way down just like they are on the way up. Of course is it that easy?
No, it is not. Yes, you can get the carry but if there is excess or even normal volatility depending upon the leverage being used you will blow up in traders terms. If this is the case, and it is, then what should a trade be focusing on when they are trying to execute the carry trade? Well the obvious answer is volatility.
You can use several different methods to estimate volatility. You can use the standard volatility index for the SP500. While it is designed and used primarily for equities it is a good estimate of volatility for most asset classes. Now days you can just use a currency volatility index like those from JP Morgan or many of the other investment banks.
If you are trading the carry trade then you should be using a volatility filter to greatly improve your results. If you are not trading the carry trade then you are also missing out on some great uncorrelated and relatively easy returns. And finally if you are not macro trading then you are missing out. You should be taking advantage of all the opportunities in the world and not just in stocks. - 23218
They trade not only different asset classes but multiple strategies within each asset class. For instance in stocks they will trade outright long and short positions, merger arbitrage deals, asset class arbitrage where you trade the equity against debt, and even pairs trading. They do much of the same in commodities and currencies as well. Essentially they are looking for sources of return wherever they can find it.
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.
To make money in the carry trade you go long a high yielding currency and go short a low yielding currency. By doing this you are able to earn the interest rate differential which is simply the difference between the two currencies interest rates. You can also of course earn money by being right on the trade and the direction.
To really juice the returns available from the carry trade you can and probably should use some degree of leverage. Some traders are modest and only use two to four times leverage while others are aggressive and use up to fifty times leverage. While high leverage is great when you are right they can be disaster when you are wrong as the losses are magnified on the way down just like they are on the way up. Of course is it that easy?
No, it is not. Yes, you can get the carry but if there is excess or even normal volatility depending upon the leverage being used you will blow up in traders terms. If this is the case, and it is, then what should a trade be focusing on when they are trying to execute the carry trade? Well the obvious answer is volatility.
You can use several different methods to estimate volatility. You can use the standard volatility index for the SP500. While it is designed and used primarily for equities it is a good estimate of volatility for most asset classes. Now days you can just use a currency volatility index like those from JP Morgan or many of the other investment banks.
If you are trading the carry trade then you should be using a volatility filter to greatly improve your results. If you are not trading the carry trade then you are also missing out on some great uncorrelated and relatively easy returns. And finally if you are not macro trading then you are missing out. You should be taking advantage of all the opportunities in the world and not just in stocks. - 23218
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.
posted by X - Men @ 3:31 AM
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