CLASSIC TECHNIQUES
On Foreign Exchange Trading
Trend-Following And The Interest Carry Trade
by Russell Sands
Here's a look at how the Turtle system can be combined with forex trading.Forex trading has been around quite a while, and so has the Turtle system. But it has only been in the last year or so I figured out how to put the two together. After about six months of work, the first Turtle foreign exchange manual was written, and the system released at the beginning of 2007. We all know that trend-following is a valid concept of trading, and we also (should) all know by now that currencies are among the best trending of all markets, so it is natural we should blend them together.
WHAT IS THE CARRY TRADE?
There is a fundamental concept of all foreign currency trading known as the "carry trade." It is not a part of the Turtle trading method, but it still has an effect on our trading. When you trade a forex pair, you are buying the currency of one country and selling that of another. Every country has interest rates, and of course, not only are there disparities among nations, but rates are changing all the time.
Now, whenever you buy the currency of one country, you effectively own that money, and you are entitled to receive interest on it at whatever rate that country happens to be paying on its money. Conversely, if (or when) you sell short the currency of another country, you are actually "giving away" their money, and you would be obligated to pay interest on it as well (again, at whatever rate that country charges).
As an example, if I were to go long the dollar-yen forex pair, I would actually be buying US dollars and selling Japanese yen. And I would be entitled to collect the interest on my dollars at whatever interest rate the US government happens to be paying. At the same time, I would also be obligated to pay interest on the yen to whomever I sold it to, at whatever rate the Bank of Japan happens to being paying on its money. Since forex trading always involves the simultaneous purchase of one currency while selling another, this situation is always going to exist to some degree on every trade we make.
When I say I am entitled to collect interest on the currency I own and pay interest on the currency I sell, the question you would most probably ask is who is on the other side of this trade. Who pays me the interest I am entitled to, and to whom do I have to pay out interest on the money I sold? For simplicity's sake, the answer is that it's your brokerage firm who both pays and collects this interest.
For every day you hold a position, your brokerage firm will look at which currency you are long and pay you interest on your money. They will also look at which currency you are short and charge you interest on that money. And depending on which country has the higher interest rates, you will either make money or lose money on this deal. In addition, depending on the interest rate differential between the two countries whose currencies you are trading, this can either be just a few cents per day or add up to a significant amount of money. And the more you trade, the more this effect will become significant over time.
...Continued in the October issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the October 2007 issue of Technical Analysis of
STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.
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