MENU Show navigation FXStreet Trading Studio Gianluca Privitera, CIM Independent Analyst Follow Preparation or Devastation? Don’t Get Caught in a Bad Carry Trade EDUCATION | 3/18/2019 12:56:11 PM GMT What’s the Worst that Could Happen? While global Central Banks are not cutting rates yet, their synchronized rate-hike-hiatus has made it a very real possibility heading into 2020. If that happens, the beloved carry trade will fade off into the sunset as the market punishes traders that didn’t protect their downside. Some would argue that there is still room to run in this cycle (and they may be right), but the increasing risks of implosion certainly warrant a more prudent approach to the carry trade. Long USD/JPY and Long USD/CHF have been the most popular carry trades during the most recent tightening cycle and should remain that way if US Dollar strength and low FX volatility persists. But what happens if that changes? If we do see the end of the tightening cycle, you will likely see liquidation begin in these positions. As most of the early exiting will come from hedge funds and other large traders, the crash could be fast and furious. The implosion is further exacerbated by the high degree of leverage in FX markets, and those who are late to the party will be in a world of pain. Once the loss on the position exceeds the average annual yield from the carry, the trade is toast. Figure 1 - USD/JPY Weekly Chart (NetDania) Figure 2 - USD/CHF Weekly Chart (NetDania) Protecting the DownsideThose who are not ready to take money off the table should at least be looking to protect it. Novice traders often find themselves in a single carry trade without being hedged, which is how trouble starts. Experienced traders instead own a portfolio of carry trade positions that lowers risk through diversification. This is great if you see a drop in just a single pair, but the others move in your favour. But this alone won’t insulate you from downside risks of a broad USD selloff. This is where options come in. calls are worth a look. The trick is finding an OTM option with a low enough premium that it doesn’t eat up your carry profits, but not to far OTM that the protection is insufficient against devastating spikes in JPY or CHF. Another strategy that has gained traction is selling puts rather than buying calls. When Put sales are combined with a carry trade, you get additional yield from the premium. This is great in low volatility environments, but if central banks stop tightening there will be downside risks. It is more prudent to hedge these with a collar strategy to reduce costs of hedging, but you will be forgoing some upside. 1 WEEK Avg Forecast 112.27 75% Bullish 17% Bearish 8% Sideways Bias Bullish 1 MONTH Avg Forecast 111.26 43% Bullish 57% Bearish 0% Sideways Bias Bearish 1 QUARTER Avg Forecast 110.77 36% Bullish 57% Bearish 7% Sideways Bias Bearish Updated Mar 15, 15:00 GMT Figure 3 - USD/JPY Forecast Poll (FXStreet) 1 WEEK Avg Forecast 1.0028 56% Bullish 33% Bearish 11% Sideways Bias Bullish 1 MONTH Avg Forecast 0.9977 32% Bullish 45% Bearish 23% Sideways Bias Bearish 1 QUARTER Avg Forecast 0.9945 32% Bullish 51% Bearish 17% Sideways Bias Bearish Updated Mar 15, 15:00 GMT Figure 4 - USD/CHF Forecast Poll (FXStreet) Note: All information on this page is subject to change. The use of this website constitutes acceptance of our user agreement. Please read our privacy policy and legal disclaimer. Opinions expressed at FXstreet.com are those of the individual authors and do not necessarily represent the opinion of FXstreet.com or its management. Risk Disclosure: Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts. Education feed EDITORS’ PICKS EUR/USD slides sub-1.1300 as the dollar accelerates advance GBP/USD clings to modest recovery gains above 1.3300 Gold: Pressure persists November low at risk of giving up Gold fell to a 1-month low of $1,763.33 a troy ounce, bouncing just modestly from it and currently trading around 1,767.00. The bright metal weakened the most during US trading hours, as the American dollar met some market’s favour. ETH outperforming its peers, BTC struggles and XRP bearish BTC refrains from making new highs as Tuesday’s gap-fill kills uptrend continuation. ETH outpaces its peers by barely hitting new highs. XRP price again looking for direction as investors interest wanes. Cyber Monday 2021 Discounts! Glued to your trading screen on Cyber Monday? Upgrade your skills by signing up for FXStreet’s Premium service, offered at a discount of up to 50%. Fellow traders have already taken advantage of Black Friday profits. What about you? RECOMMENDED LESSONS Making money in forex is easy if you know how the bankers trade! Bradley Gilbert Traders4Traders Discover how to make money in forex is easy if you know how the bankers trade! 5 Forex News Events You Need To Know Littlefish FX Analysts Littlefish FX In the fast moving world of currency markets, it is extremely important for new traders to know the list of important forex news... Top 10 Chart Patterns Every Trader Should Know Colibri Trader Colibri Trader Chart patterns are one of the most effective trading tools for a trader. They are pure price-action, and form on the basis of underlying buying and... 7 Ways to Avoid Forex Scams Yohay Elam FXStreet The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams? What Are the 10 Fatal Mistakes Traders Make Colibri Trader Colibri Trader Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process. STRATEGY MONEY MANAGEMENT PSYCHOLOGY ©2021 "FXStreet" All Rights Reserved Disclaimer