Sunday, September 28, 2008

Cost of Carry

The Lonely Trader commented on my post about a short Euro position. He runs an excellent blog on trading and wanted to point out that cost of carry is a very important element of any trade. It can eat away at profits is negative or provide a profit is positive and the market does not move. My friends continually get on me about my desire to find positive carry in all my trades. They refer to me as a “yield monkey” and have termed one of my rules of trading (I have a few of them)“The Triad Theory”. Let me explain….

Triad Theory. Market can do three things, Go up, Go down or stay the same. If you can put a trade on where two of those three scenarios generate profits you have just increased your chances of making money. When looking at trades I am always looking for positive carry. That is what attracts me to trading Emerging Market currencies, YIELD. I am well aware that there is a reason for the yield (the risky nature of the currency) but over time and with the right mixture of risk it pays off. I am about to date myself, but two of my favorite books are "Den of Thieves" and Highly Confident". Both books were about Drexel Burnham Lambert, the 1980's Investment house, and its number one trader Michael Milken. Michael Milken came up with a theory on junk bonds (and I am going to simplify it here), If you put together a diversified portfolio, some will fail, some will do well and others will just plod along (earning yield) and the overall return should be superior then a regular portfolio. Looking at Emerging Market currencies I believe it is very similar. Take a large sampling of currencies into a basket, some will do well, others will suffer but over all you should do OK. During times of low volatility this strategy works much better. I also like to group currencies into regions, maybe be long yield in Latin America, but short yield in Asia. This would depend on my view of the Economic conditions of the regions.

Please remember that I trade for a large financial institution and not on a retail level. As Lonely Trader points out the carry on being short euro is negative. In my world over the last two weeks it has actually been positive due to the world wide scramble for dollars. Has this been passed along to the retail portals, I really do not know. The thing to remember is that carry is an important part of any trade. Time can be a benefit or a hindrance depending on how your trades are structured. In times such as this yield should be looked at as a “kicker” and not the reason to enter a trade. Volatility is way to high, but when markets calm down I am one trader who will be looking at it once again.

Comments would be appreciated.

Good Luck and Good Currency Trading.



Anonymous Anonymous said...

Nice roll today on that short trade man. Very nice indeed.

10:29 PM  
Blogger Banker said...

Thanks LT

Even a stopped clock is correct twice a day !!

Good Luck

5:30 AM  

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