Another interesting article back from December 14, 2012...
Know When to Hold ’Em… Know When to Fold ’Em
By Sean Hyman, Editor Currency Cross Trader
During a recent interview, I was asked which kind of currency trade I thought was the most profitable. That was a heck of a question, given the current gyrating state of the market.
I told the interviewer that the best trades were those almost no one wanted to do – in other words, the ugliest ones I could find.
For example, a few years back, when I worked for a currency-trading firm, the most profitable strategy was the one preferred by very patient, long-term traders from Japan.
You see, Japan’s interest rates have been at near-zero for more than a decade. So it’s no surprise that Japanese investors sought better returns elsewhere. A few years ago, they found it in places like the U.K. and Australia, where interest rates climbed as high as 6%, while rates languished between 0% and 0.1% in Japan.
Their strategy was to sell the low-yielding yen and buy the high-yielding U.K. pound or the Aussie dollar. Thus, their profits came from the difference. If the pound earned a 4% yield and the yen was at 0%, investors clearly would earn 4% on their money. That’s my kind of trade.
Supercharge Your Returns Through the Forex Market
While earning 4% on your money annually sounds pretty good, the return was actually far better – thanks to the way leverage works in the currency market.
Back then, a trader could borrow against their account funds anywhere from 100-to-1 up to 400-to-1. These days, leverage can be anywhere from 20-to-1 up to 50-to-1, thanks to new restrictions. However, the Japanese are conservative traders. So let’s say they leveraged their accounts by just 10-to-1. That turns a $10,000 account into $100,000 worth of investing power.
The key here is that these investors wouldn’t earn a 4% yield on just $10,000 – but on $100,000. That’s what I call earning interest on steroids. Instead of earning $400, they’d pocket $4,000, ratcheting their actual yield up to 40%.
Another well-kept traders’ secret is to use low leverage and hold the position for an entire year.
Know When to Hold Them and When to Fold Them
But it’s tough to get currency traders to do either one of these.
There will be wild swings throughout the year. So you have to mentally prepare yourself. But back then, if you held on, the strategy came through.
This “carry trade” strategy performs best when economies are recovering – not when they’re contracting, as many now are. There’s a time to use this strategy, and there’s a time to step aside.
It worked well between late 2000 and mid-2007, but this strategy has been dead for around five years. Many traders think those “gravy days” are gone forever.
But that’s not my view…
Earning Over 30% a Year…
Over the past couple of months, some traders have been able to take advantage of this interest-earning strategy again.
The difference is that currency yields are no longer between 4% and 6% anymore. However, the Aussie dollar still yields 3.25%, while the Japanese yen remains stuck at 0.1% – and for me, that spells a major opportunity.
Buying the AUD/JPY pair in the Forex market, you can earn the difference between the two interest rates, which would bring about an annual yield of 3.15%. And with leverage, this would end up being a 31.5% return – which is not bad going in today’s low-yield world.
Essentially, the global economy is in recovery mode and that’s why the carry trade has returned. European bond yields are falling again, global stocks are rising and many economies are growing, even if the pace is slow.
As long as you’re low leveraged and able to handle the wild swings of thousands of pips either way, you’ll likely do well buying the high-yielding AUD/JPY currency pair and tucking it away for a year.
But for those of you that don’t have a Forex account and still want to get in on the action, you can do so through your brokerage account.
You can buy the CurrencyShares Australian Dollar ETF (FXA) through your brokerage account and earn around 3.36% by holding this position for a full year. This ETF tends to pay out a dividend around the first week of the month.
A little word of advice: it’s best to forget about the principal amount you invested, because it will gyrate all over the map throughout the year. However, in the end, you’ll likely be at break-even or more on the principal, but you will have earned a killer amount on interest.
Whether you go the Forex or the ETF route, the carry trade is back and this interest-earning strategy can be a winner. Get in on it before the masses figure it out. You’ll be glad you did.
Have a nice day!
Sean Hyman
Editor, Commodity Trend Alert
Know When to Hold ’Em… Know When to Fold ’Em
By Sean Hyman, Editor Currency Cross Trader
During a recent interview, I was asked which kind of currency trade I thought was the most profitable. That was a heck of a question, given the current gyrating state of the market.
I told the interviewer that the best trades were those almost no one wanted to do – in other words, the ugliest ones I could find.
For example, a few years back, when I worked for a currency-trading firm, the most profitable strategy was the one preferred by very patient, long-term traders from Japan.
You see, Japan’s interest rates have been at near-zero for more than a decade. So it’s no surprise that Japanese investors sought better returns elsewhere. A few years ago, they found it in places like the U.K. and Australia, where interest rates climbed as high as 6%, while rates languished between 0% and 0.1% in Japan.
Their strategy was to sell the low-yielding yen and buy the high-yielding U.K. pound or the Aussie dollar. Thus, their profits came from the difference. If the pound earned a 4% yield and the yen was at 0%, investors clearly would earn 4% on their money. That’s my kind of trade.
Supercharge Your Returns Through the Forex Market
While earning 4% on your money annually sounds pretty good, the return was actually far better – thanks to the way leverage works in the currency market.
Back then, a trader could borrow against their account funds anywhere from 100-to-1 up to 400-to-1. These days, leverage can be anywhere from 20-to-1 up to 50-to-1, thanks to new restrictions. However, the Japanese are conservative traders. So let’s say they leveraged their accounts by just 10-to-1. That turns a $10,000 account into $100,000 worth of investing power.
The key here is that these investors wouldn’t earn a 4% yield on just $10,000 – but on $100,000. That’s what I call earning interest on steroids. Instead of earning $400, they’d pocket $4,000, ratcheting their actual yield up to 40%.
Another well-kept traders’ secret is to use low leverage and hold the position for an entire year.
Know When to Hold Them and When to Fold Them
But it’s tough to get currency traders to do either one of these.
There will be wild swings throughout the year. So you have to mentally prepare yourself. But back then, if you held on, the strategy came through.
This “carry trade” strategy performs best when economies are recovering – not when they’re contracting, as many now are. There’s a time to use this strategy, and there’s a time to step aside.
It worked well between late 2000 and mid-2007, but this strategy has been dead for around five years. Many traders think those “gravy days” are gone forever.
But that’s not my view…
Earning Over 30% a Year…
Over the past couple of months, some traders have been able to take advantage of this interest-earning strategy again.
The difference is that currency yields are no longer between 4% and 6% anymore. However, the Aussie dollar still yields 3.25%, while the Japanese yen remains stuck at 0.1% – and for me, that spells a major opportunity.
Buying the AUD/JPY pair in the Forex market, you can earn the difference between the two interest rates, which would bring about an annual yield of 3.15%. And with leverage, this would end up being a 31.5% return – which is not bad going in today’s low-yield world.
Essentially, the global economy is in recovery mode and that’s why the carry trade has returned. European bond yields are falling again, global stocks are rising and many economies are growing, even if the pace is slow.
As long as you’re low leveraged and able to handle the wild swings of thousands of pips either way, you’ll likely do well buying the high-yielding AUD/JPY currency pair and tucking it away for a year.
But for those of you that don’t have a Forex account and still want to get in on the action, you can do so through your brokerage account.
You can buy the CurrencyShares Australian Dollar ETF (FXA) through your brokerage account and earn around 3.36% by holding this position for a full year. This ETF tends to pay out a dividend around the first week of the month.
A little word of advice: it’s best to forget about the principal amount you invested, because it will gyrate all over the map throughout the year. However, in the end, you’ll likely be at break-even or more on the principal, but you will have earned a killer amount on interest.
Whether you go the Forex or the ETF route, the carry trade is back and this interest-earning strategy can be a winner. Get in on it before the masses figure it out. You’ll be glad you did.
Have a nice day!
Sean Hyman
Editor, Commodity Trend Alert
