Introduction to Forex Carry Trade

Carry Trade is an effective long-term trading strategy and a strong force driving key Forex trends.

What is Forex Carry Trade?

Forex Carry Trade means selling a low-interest-rate currency and buying the same amount of a high-interest-rate currency. The concept is to make money based on the interest-rate differential.

Popular Currencies for Carry Traders

A carry trade will go long on currencies such as the New Zeeland Dollard, the Australian dollar, or the Turkish Lira, and go short on currencies such as the Japanese yen and the Swiss Franc.

The most popular currency pairs for carry trading are:

■ AUD/JPY, NZD/JPY, EUR/JPY, USD/TRY, and GBP/CHF

Carry Trade can also mean borrowing in a low-interest-rate currency, converting it to a high-interest-rate currency, and buying the highest-rated bonds (check the Yen Carry Trade below).

Read more: Forex Carry Trade

Commitments of Traders

COT or Commitments of Traders refers to a report that is published by the CFTC which presents the aggregate short and long trading positions in the US Futures Market.

This report includes the aggregate trading positions in many different asset classes and that includes Forex pairs as well. The report was originally introduced back in 1962 when it was incorporating thirteen agricultural commodities.

The 'Commitments of Traders' is used as an indicator of the general market sentiment. The really important information deriving from this report involves the aggregate positions of Non-Commercial Traders.

Basic Information regarding Commitments of Traders

-The COT report is published weekly (3:30 EST, Fridays) by CFTC and presents information about interest rates, stock indices, and Forex rates.

-The COT report measures the total positions of three different market participants: commercial, non-commercial traders, and small speculators in the US Futures Market.

(i) Commercial Traders

(ii) Non-Commercial Traders

(iii) Small Speculators

Read more: Commitments of Traders Report

What is Forex Carry Trading? -Basic Information

Carry trading refers to a trading strategy that involves borrowing at a low interest rate and buying an asset that offers a higher rate of return. In practice, Forex carry traders are borrowing in a low-interest rate currency to buy another currency that provides a higher interest rate.

• The basic risk of a carry trade involves a decline in the currency pair against the direction of the trade greater than the interest rate differential.
• Carry traders do not mind either about the trading spreads or about the trading commissions charged. They do mind a lot about the SWAP rates of each currency pair.
• Each Forex broker offers different SWAR rates for each currency pair, therefore, Forex carry traders need to research the market well and choose a safe Forex broker that offers the best SWAP rate for their cause.

What is a SWAP or Rollover Rate?

A Swap Rate or else an Overnight Rate or else a Rollover Rate is an interest earned or paid for holding a Forex trading position overnight. This interest is earned or paid every business day at exactly midnight. The Swap Rates are tripled at the end of each Wednesday to cover the two missing rates of Saturday and Sunday.

COMPARE SWAP FOREX RATES (UPDATED EARLY 2024)

COMPARE ALSO: » FOREX AUTO-SYSTEMS | » FOREX BROKERS FOR TRADERS | » CURRENCY PAIRS

Read more: Carry Trade Forex Brokers

Strategies for Trading the Forex Fundamentals

There are several different strategies to trade the Forex Market. This analysis presents four (4) trading strategies based exclusively on fundamental analysis.

What is Forex Fundamental Analysis?

Forex fundamental analysis consists the interpretation of economic, strategic and political factors and aims to forecast the future exchange rate of a Forex pair. These factors may affect directly or indirectly the future demand and the supply of a currency pair.

How Fundamental Analysis can be combined with Technical Analysis

Most Forex traders are seeking opportunities in the currency market by using solely technical analysis tools (such is the MACD Histogram, Pivot Points, Support, and Resistance). Usually, they target profits of 50-200 pips per trade. The problem with this approach is the execution of tens of trades on a daily basis, a factor that increases significantly the trading cost. This analysis presents a different fundamental approach. This does not mean that technical analysis becomes useless, technical analysis will still be useful for determining entry and exit points.

◙ Using Fundamental Analysis to determine what to Buy and Technical Analysis to determine when to Buy

Read more: Trading the Forex Fundamentals

Forecasting Market’s Volatility using two CBOE Volatility Indexes (VIX & Skew Index)

Options volatility indexes are used in forecasting future market volatility and the investor sentiment. The analysis of such volatility measures may assist investors managing and diversifying their portfolio more effectively.

In this analysis, two (2) important market volatility barometers are presented, both calculated based on the volatility of CBOE options:

• CBOE Volatility Index (^VIX)
• CBOE Skew Index (^SKEW)

The CBOE includes several other volatility indexes on stock indices, ETFs, shares, commodities, and tradable volatility contracts (VIX options, VIX futures, etc.). At the end of this analysis, you may find the full range of CBOE volatility indexes.

(1) CBOE Volatility Index (^VIX)

The CBOE Volatility Index (VIX) is considered the most important barometer of equity market volatility. The VIX Index is based on options contracts, on the S&P 500 Index (SPX). It is designed to reflect investors' consensus view of 30-day expected stock market volatility.

The Role of Options Volatility as a Forecasting Tool

The price of the call and put options can be used to calculate implied volatility because volatility is one of the factors used to calculate the value of these options. Any volatility modification of the underlying instrument makes an option contract more (or less) valuable, as there is a greater (or smaller) probability that the option may expire in-the-money, at the end of its maturity.

■ The Greater the Options Volatility → the Greater the Option Price -Therefore, other things being equal, a higher option price incurs greater volatility.

Note: The other two main factors when pricing an option, except volatility, include intrinsic value and time to maturity.

Read more: CBOE VIX and Skew Index

Foreign Exchange Reserves

The Foreign Exchange Reserves are the foreign currency deposits held by the Domestic Monetary Authority (Central Bank or other authority) of each country. The following table presents the countries with the highest foreign-exchange reserves by incorporating the gold reserves.

Foreign Reserves -Explanation

Forex reserves are currency assets such as monetary, gold, Foreign marketable securities, and the reserve position in the IMF.

Purpose

The Foreign exchange reserves help countries to fulfill their international payments but also to hedge against exchange rate risks and to protect their currencies against speculative attacks.

Reserve Currencies

A reserve currency (or else anchor currency) is a currency that is held by governments and large financial institutions as Foreign exchange reserves. A reserve currency is often seen as a safe-haven currency in case of financial turmoil, but also as a hard-currency against weak currencies. Major reserve currencies include the US Dollar, the Euro, the British Pound Sterling, and the Japanese Yen. China's currency (Yuan Renminbi) is not considered a reserve currency due to the Chinese government's monetary controls. 

Highest Foreign Reserves

The table below presents countries with the highest reserves by incorporating the following reserve types:

■ Foreign Currency Deposits (USD, EUR, GBP, CHF, JPY etc)

■ Gold Reserves

■ Special Drawing Rights (SDRs)

■ IMF (International Monetary Fund) Reserves

Note: The Forward Currency SWAP Contracts are not incorporated (until they mature)

Read more: Foreign Exchange Reserves