Mar

24

I'm starting to look for systematic ways to play currencies. The most apparent one is the carry trade based on relative interest rates. I'm also going to look at relative real interest rates, relative gdp, income, balance of payments, and money supply.

First pass: literature suggests carry trade is volatility dependent. Looking at PowerShares DB G10 Currency Harvest fund (DBV) which buys the 3 highest yielding currencies in g10 and shorts the 3 weakest, is down 6% since inception on 9/18/06. Indicator: compute 21-day standard deviation of close-close[1] changes and then rank today's reading over the last 90-days.

Buy DBV when the indicator is in the bottom 1/3 of the range and sell when it exits the bottom 1/3 (vol is low)

Total Return 32%
Avg 1.1%
Count 29
Std 3.0%
t 2.0

Sell short when the indicator is in the top 1/3 of the range and buy to cover when it exits the top 1/3 (vol is high)

Total Return 21%
Avg 1.2%
Count 17
Std 6.2%
t 0.8

Seems to work symmetrically although this crude strategy appears better at capturing the positive risk premia of the carry trade.


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2 Comments so far

  1. jeff Watson on March 24, 2011 6:55 am

    My friends that play the carry trade in currencies have told me that they are generally long the currencies with the higher interest rates and short the currencies with the lower interest rates. I wonder if ETF’s are a a rational way to put on a carry trade, as the vig, hidden fees, slippage, and mistakes are very expensive, and can kill the player. It is good to remember that ETF’s are a retail way to play a market. One would probably be better off playing the cash or futures markets than ETF’s, but I have made no quantitative study and this is only an educated guess. Do carry trades work better when there is a period of relative calm in the currency markets, and does the increased volatility put one in harms way? Is there less on the plate with currencies vs. grains in a typical carry trade? What is the best vehicle to get a currency carry trade down, and are there any good substitutes?

  2. Alaric Investments on March 24, 2011 10:43 am

    I would avoid ETFs altogether and invest directly in the cash and futures markets…costs, lack of transparency, etc.

    It also pays to look at technical analysis when dealing with currencies and at times avoid certain currency markets altogether when the big guns are firing (yen in particular these days)…you cannot fight the forces against you the the FX markets, they have infinite resources.

    Quantitive and technical analysis are at times not enough - a good qualitative understanding of how government officials view their currency and the country’s cultural experience with fiat currencies is also necessary; for example, you would expect a more hawkish, firmer currency policy from a German or Brazilian , where hyperinflation occurred, as opposed to the U.S., which never experienced hyperinflation….while qualitative analysis will never suffice alone, over the longer term I have found that it definitely helps

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