A lot of banks are presently debasing their currency through monetary easing because many investors are greatly besieged by pressure to attain meaningful yields. Three currencies including the euro, dollar and sterling offer yields almost next to zero which the yen has been stuck in the same position for about two decades. The dynamics playing the effects of inflation yielded negative yields for traders and investors.
The environment seen can be used as an advantage by traders for the differential between different nations’ interest rates through what is collectively known as the “carry trade”. This rivets loans with a relative lesser yield in this case sterling- which is presently yielding 0.5 %. Investing that amount of loan into a currency wherein higher yields can be achieved such as South Africa’s rand which is presently on a 5 % yield.
Nearly every retail investor use spread betting platforms that have no currency base risk attach to the trade. For instance, if your trade a yen-Aussie-dollar carry trade it is prudent to sell yen and purchase Aussie-dollar since it would not entail paying interest on the yen while earning interest on the latter. It would not necessitate a conversion of sterling into either the two currencies therefore you can take a direct and advantageous position in the two currencies.
Many experienced traders are accustomed to this form of trade and extra care should be practiced for new traders. The trick is to go short on one currency and go long on another which leads to a double risk of their investment. In order for carry trades to benefit traders, currency pairings need to be stable enough so that gains that resulted from yields are not removed by price fluctuations.
Traders ought to search for currencies that are well economically and politically stable. Moreover, currency pairs should have a wide gap in terms of differential interest rates. With the current stage of monetary easing, differentials are greatly reduced which basically means the small differentials actually mean additional risk for traders.
Analysts predict that trades will work much better in the medium-term especially that macroeconomic fundamentals are present. The dollar-rand trade is becoming quite attractive and will hopefully shine and outperform its currency counterpart in the industrial action within South Africa.
Inexperienced traders are urged to be extra vigilant regarding exotic currency pairings. It is very unpredictable how much liquidity suddenly drops off when you go for such pairings. Furthermore, traders need to be sharpen their senses by keeping a good eye on the economy of the related currency and other data which minute changes can have dire consequences if remained unchecked in a regular basis.
Making profit from the carry trade in the present erratic environment is a difficult but possible task if done correctly, wisely and patiently. For the experienced and hardened traders it really does make a whole lot of sense continuing the trade despite this highly complex process.