Magazine article Modern Trader

Tracking Risk Appetite

Magazine article Modern Trader

Tracking Risk Appetite

Article excerpt

The conventional wisdom about trading is that there are two dimensions traders work within to shape their trades: fundamentals and technicals. Fundamental analysis looks at the economic conditions that influence price movements, while technical analysis looks specifically at price movement, believing that the fundamentals are worked into the price. The main fundamental forces for forex markets are interest rate differentials, economic growth and inflation expectations. In normal times, the most important fundamental force is interest rate differentials. This force results from the attraction of a return on leveraged investment when a differential in rates occurs. When hundreds of millions of dollars are resting in cash, the goal is to get paid on interest income. If the difference in rates among currencies is great, it results in the strategy where investors and traders borrow the lower interest currency and invest in the higher interest currency or assets of that currency. This strategy is known as the carry trade.

For years, carry trade strategies made a lot of sense and received superior returns. Yet the risk of having the borrowed currency fall in value and then having to buy it back with losses is what carry traders always fear. Through the years, the carry trade strategy had swings in fortune as world economic trends changed. Retail traders can track carry trade conditions by monitoring the I Path Optimized Currency Carry ETN (ICI), which tracks the carry trade strategy and its price path (see "Carried away"). …

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