The Secrets to Forex & Protecting Your Carry
You must read the prior articles first.
If this was a video game you would probably be trying to skip the conversation boxes at this point. Don't try to speedrun this, you'll die at the boss.
---------------------------------------
I'm sure you're tired of all the poetry and want to get straight to the money. Money, after all, is the best form of entertainment.
Now, last time we left off with timeframes and carry conditions, key components of the overall risk management message I want to get across. I figured that most retail traders operate on multiday/multiweek positions. Most know next to nothing about carry risk or other unique risks present only for non-intraday traders.
If you intend to hold positions across several weeks/months (see pt. 3 for the definition), then this section is the most important of all the articles to come. In addition, I recommend doing additional research, especially if you have a job, are in schooling, or other responsibilities; because understanding this risk (and potential reward) can be very beneficial for those with limited time to spend.
Part 1: Country-level Assets
All wealthy people own assets.
Assets can appreciate. If you 'own' a lot, you are, by default, wealthy. At least, for a brief moment in time.
When you trade in forex, you are investing in a type of asset underwritten by a 'country' and paired with a similar underlying. The country creates the supply, and sets minimum standards in demand via tax law. Like businesses with stocks, countries with currencies and bonds can default, and flatline, leading to a breadline utopia. Inversely, they can also grow, and produce something of market value; and then provide returns to everyone that bet something on them.
Some countries are flailing about, some countries are stable, and some are growing with seemingly no obstacles in sight. Which one would you want to invest in? Remember the dividend question?
Before some median-salary economist gets in a huff, yes it's not always as simple as 'growing country = growing interest rates.' But here's what's important for retail traders:
Central banks manage these 'country-level' assets with an evolving toolbox to variable acclaim. I recommend doing your own research into that topic, because it's too far outside the scope of these articles, and there are no unified verdicts on the 'science' behind any of it. The important thing to understand is that when you invest in these country-level assets, some countries demand a fee rate, and some offer a dividend rate. THAT'S IT. Room temperature or higher IQs will get this.
Part 2: Free to Play vs Fees to Play
You can find these rates by googling: 'central bank interest rates.'
Those negative rates are FEES TO PLAY. Zero or higher is FREE TO PLAY. If you hold currency at a broker, these rates are realized and charged or credited to your market position at the daily rollover event. This occurs at the end of the 24hr cycle set to City time. So if you hold positions over 24hr cycles, you will be charged or credited REAL MONEY (no delivery gimmicks).
Now, you can't trade currency in isolation in forex, it's always in the form of a pair. In case you haven't figured this out yet, the forex trader is the type of player these articles are designed for. This means, in lazy phrasing, that you are betting on the demand for the money (investor appeal) of one country AGAINST another. If you want to invest in a country as is, you can opt for national or municipal bonds, but note they do have slightly different carry conditions.
But to stay on target, what do you think happens when you match a higher rate with a lower rate?
The USD is a higher rate than the JPY. The USD is free to play, the JPY charges a fee to play. When you open a position in the market, you are FUNDING one of those currencies (basically against the other). This means you are liable to the interest rate gap. Brokers have an unnecessarily complicated explanation for why they HAVE to pay you money (or take your money) even though price action may not technically move from 23:59 to 00:01. They want to balance the books in a way they are comfortable with, because they have lots of liabilities with major liquidity providers. The net takeaway is that most brokers will generally charge or credit based on the interest rate gap between the currencies in your selected pair. So carry conditions are relevant accross most brokers unless you have a based Islamic account.
Note that most brokers have a separate fee (usually .25%), which means if the interest rates are equal then you still get charged at rollover. There are other subtractions brokers will make as well (never in your favor), sometimes cutting deep in the rate gap. Unsurprisingly, they want to pay you as little as possible; in some cases, you can be charged on rollover regardless of gap or position direction. This is why you need to check the 'specification' of the pair in your MT4 to see the swap (or use a calculator provided by your broker.) Some brokers have special rules for emerging currencies with high rates like 8%, other brokers may offer advantages for trading these depending on their business structure.
Wed to Thurs rollover is a x3 event, basically to make up for the lack of a rollover event on Sat and Sun night.
You're probably wondering why these 'small percents' matter. After all, you're in forex to make highly leveraged internet magic money, not some quarterly dividend payment like your boomer parents.
Part 3: Make America Think Again
But it's just pennies a day right, who cares?
Carry conditions can cost or credit you pennies a day or thousands of dollars a day, depending on the size of your position or the pair in play. On some pairs, you can make 15~ USD a day with just 1 lot in the market. That's over 5k a year USD. That's the equivalent of 540 pips a year, WITH 1 LOT ON 1 PAIR. And all you have to do, is fund a high rate currency bet against a low rate currency on a popular broker. That's it. No technical moonworshipping required. No stalking some coin startups social media for pump and dump schemes. No staying up all night worrying about the West going to war with Iran because you longed the Euro before dinner. It's the opposite of the coin flip, its coin printing.
Many retail traders are from developing and emerging countries, it can be an excellent opportunity for men and women of all ages. Its like working at Wall Street and sending the remittances back, all from the ease of your home; without any political, religious, cultural, or economic barriers to get in your way. Sure it's not really that convenient. But the analogy would've been really cool if it worked.
So what can happen, for example. At .40 lots for a full position, you would net 1.80 USD a day. Assuming 2 weeks to fill a position at optimal entry points (we'll talk about this later), and a remaining 2.5 month duration (5 fortnites), you net about 130 from carry credit payments during that trade period (1/4 a year), and be able to close with a very profitable or at least at a net-positive price level. Keep in mind, the average yearly takehome is anywhere from 2k-10k in developing countries. 1.8 a day can represent significant supplimentary income, and you only need 100-250 (in USD equivalent value) to support margin at most brokers. You could reinvest those winnings over the course of the first year and start the next year earning 7-8 USD a day.
Now some of you might have more cash to waste. With a career in a developed country, maybe you have 25-50k to responsibly throw around in your 20s, no family, STEM job, good rent contract, little student debt, etc. We can upgrade that position size to 4 to 8 lots. 18-37 USD per day. You'll be doubling (before tax) your initial capital every 4 years.
Part 4: Fields of Pink
But wait, what if you have the opposite position? You fund a low rate currency against a high rate currency, or your trash broker demands fees on both. Your inverted head and shoulders 4h pattern looks (and smells) great, and you're ready to long the EURUSD. You plan to hold this one for a month at least, until it hits some absolute number like 1.200 (because it's the fifth wave in some model a statistician invented 40 years ago), and therefore, must happen. You decided your 'RR' would be 3 to 1, a 150 pip stop loss and a 450 take profit. You're already taking a tendie loan out at KFC in anticipation of a big win down the line. Meanwhile, you're losing 13 dollars a day (or let's say 0.5-2 pips worth of loss), guaranteed. Because you're paying a fee to play, while taking a bet that fails at a near 50% rate (much higher for retail), while throwing away weeks/months of time in anticipation of a result/delivery (capital opportunity cost). Now, if you had ten thousand years of nutritionally deficient ancestors, I can't blame you for this decision-making. But most of us haven't.
So here it is, another forex secret:
Quite simply, there are pairs the vast majority of you shouldn't be trading, and that includes majors with poor carry conditions (losers both ways with rollover). Pairs like CHFJPY, or any pair that has you longing the JPY or CHF (and usually EUR). Betting against the USD is another insured risk, when looking at majors. It doesn't mean you should never fund a low rate against a high rate, but you need to think in terms of FEES.
Is it worth paying a daily fee to make this trade?
Now, for the greedy. You'll need to do your own research, to decide if hunting extremely high rates on emerging/exotic currencies is the best course for you and your margin, of if settling with minimal (but not negative) rates on crosses or other majors is good enough for your strategy. My guidance is to look into emerging currencies if you don't have much time to trade daily (someone with a full-time job or family) or you don't intend to sink 1,000s of hours into mastering the intra-day trade (nightmare mode).
Part 5: Washington Consensus
Trading with carry conditions in mind can even be advantageous compared to other asset classes (like stocks or corporate bonds).
It's like trading a high yield junk bond, only you have far less risk from defaults. What's a safer institution? Some 5 month-old, toothbrush-sharing, 10 slide company with 8 employees, or the full might of a nationstate?
Sure, a few nationstates have defaulted in modern history. The upside is you usually have lots of heads-up, because default tends to be political in nature. That is, if you're a nation in need of cash, you can always get a loan. It's simply a matter of if the terms are politically acceptable for your faction. This all factors into the 'heads-up' period, alerting you to pull out or reverse your position. The US tends to sanction them beforehand (conveniently) kicking you out of those markets ahead of total economic disaster. The complete opposite occurs with some shady junk bond at 15%, where the company disappears overnight. Companies fail for the smallest things, they fail all the time, and the world goes on. A country failing is always geopolitical in nature and market rules about fair play are thrown out the window. This is an intrinsic advantage to forex and global macro tradables in general.
I'll talk more about the future risk of national defaults and the utility and primacy of forex as an asset class in the final article.
So beyond the obvious consideration, which is to fund a high rate currency against a low rate; what pairs should you trade and how else could you mind carry conditions while holding a long term position? Should you stick to emerging (exotic) currencies against safe-haven currencies? IE, you only short the EURMXN or fund against the CHF? And what indicators/models (from article pt.2) should you use to achieve the safest average price entry?
Part 6: Not All Edges are Sharpe
Forex is highly volatile, so you may have an advantage in the carry conditions, but suffer a net loss from a poor initial position when you decide to close. A currency with a negative rate could move against you, bigly. Remember, the future holds unlimited risk. But the distinction here (as mentioned in the prior article), is the resilient value in understanding that contracts can have insured risk outcomes. Cost/benefits that are legally settled (from the past) at the point of opening position and at the rollover event, even if brokers tinker with the point payouts, the 'deal' is still there in some form. Here's a poorly kept institutional secret, greed often drives the price in the direction of the higher interest rate currency in a pair over multi-month periods, so this doesn't really matter. Wealthy investors are greedy for higher payouts from emerging countries: where labor is cheaper, new factories spring up all the time, and real estate can be opportune.
Part 7: Bat Soup vs the Fortune 500
Old school risk theory in markets argues that high volatility = high risk, but in recent years it has evolved beyond such mathematical explanations, especially as consecutive market challenges broke paradigms. Boomers are slow learners, but they adapt quickly when they start losing money. The subprime crisis cost them big time. And it's true today for our sniffle pandemic. It's simple: On high timeframes across longer-term positions, macroeconomics and geopolitics reign supreme. This isn't just a forex rule. This has been true since the dawn of markets in human society, it is true today, and it will be true in the end. Regulation and interest rates are variables that follow those leaders (not precede). That is, their behavior is shaped by the first two; macro and geopolitics. Think about COVID-19. Look what a few bats and one strange wet market did this world.
Macroeconomics and geopolitics produce basic patterns in the human brain that propagate through our societies as two different frequencies: the short wavelength called fear or the long wavelength called security (interpreted in complex ways by players in markets). These are filtered by timezones, languages, civilizational and organizational biases, technology, individual upbringings, and the incumbency of delusion and greed. Nanoseconds, or years later, this all gets represented as a market outcome on a chart. Amazing that people spend so much time analyzing the chaotic patterns of some shit on a floor instead of what was on the menu last night, when they try to understand what went wrong.
So if you can understand markets during these strong periods of psychological stress, and during soft periods of algorithm auctioning and market making (call it ranging), then you can sail all the seas and survive all the storms.
This is where concepts like seasonality, ATR, regressions, psychological origination, hedging, news trading, major moving averages, and others come into play.
In the coming weeks, I'll start to break down the major components of those, and where the center of price gravity and extremes are for these higher timeframe, longer-term positions. So you can find the optimal entry opportunities for longer-term trades, while also taking advantage or hedging against carry conditions. It's time to start charting the course.
If this was a video game you would probably be trying to skip the conversation boxes at this point. Don't try to speedrun this, you'll die at the boss.
---------------------------------------
I'm sure you're tired of all the poetry and want to get straight to the money. Money, after all, is the best form of entertainment.
Now, last time we left off with timeframes and carry conditions, key components of the overall risk management message I want to get across. I figured that most retail traders operate on multiday/multiweek positions. Most know next to nothing about carry risk or other unique risks present only for non-intraday traders.
If you intend to hold positions across several weeks/months (see pt. 3 for the definition), then this section is the most important of all the articles to come. In addition, I recommend doing additional research, especially if you have a job, are in schooling, or other responsibilities; because understanding this risk (and potential reward) can be very beneficial for those with limited time to spend.
Part 1: Country-level Assets
All wealthy people own assets.
Assets can appreciate. If you 'own' a lot, you are, by default, wealthy. At least, for a brief moment in time.
When you trade in forex, you are investing in a type of asset underwritten by a 'country' and paired with a similar underlying. The country creates the supply, and sets minimum standards in demand via tax law. Like businesses with stocks, countries with currencies and bonds can default, and flatline, leading to a breadline utopia. Inversely, they can also grow, and produce something of market value; and then provide returns to everyone that bet something on them.
Some countries are flailing about, some countries are stable, and some are growing with seemingly no obstacles in sight. Which one would you want to invest in? Remember the dividend question?
Before some median-salary economist gets in a huff, yes it's not always as simple as 'growing country = growing interest rates.' But here's what's important for retail traders:
Central banks manage these 'country-level' assets with an evolving toolbox to variable acclaim. I recommend doing your own research into that topic, because it's too far outside the scope of these articles, and there are no unified verdicts on the 'science' behind any of it. The important thing to understand is that when you invest in these country-level assets, some countries demand a fee rate, and some offer a dividend rate. THAT'S IT. Room temperature or higher IQs will get this.
Part 2: Free to Play vs Fees to Play
You can find these rates by googling: 'central bank interest rates.'
Those negative rates are FEES TO PLAY. Zero or higher is FREE TO PLAY. If you hold currency at a broker, these rates are realized and charged or credited to your market position at the daily rollover event. This occurs at the end of the 24hr cycle set to City time. So if you hold positions over 24hr cycles, you will be charged or credited REAL MONEY (no delivery gimmicks).
Now, you can't trade currency in isolation in forex, it's always in the form of a pair. In case you haven't figured this out yet, the forex trader is the type of player these articles are designed for. This means, in lazy phrasing, that you are betting on the demand for the money (investor appeal) of one country AGAINST another. If you want to invest in a country as is, you can opt for national or municipal bonds, but note they do have slightly different carry conditions.
But to stay on target, what do you think happens when you match a higher rate with a lower rate?
The USD is a higher rate than the JPY. The USD is free to play, the JPY charges a fee to play. When you open a position in the market, you are FUNDING one of those currencies (basically against the other). This means you are liable to the interest rate gap. Brokers have an unnecessarily complicated explanation for why they HAVE to pay you money (or take your money) even though price action may not technically move from 23:59 to 00:01. They want to balance the books in a way they are comfortable with, because they have lots of liabilities with major liquidity providers. The net takeaway is that most brokers will generally charge or credit based on the interest rate gap between the currencies in your selected pair. So carry conditions are relevant accross most brokers unless you have a based Islamic account.
Note that most brokers have a separate fee (usually .25%), which means if the interest rates are equal then you still get charged at rollover. There are other subtractions brokers will make as well (never in your favor), sometimes cutting deep in the rate gap. Unsurprisingly, they want to pay you as little as possible; in some cases, you can be charged on rollover regardless of gap or position direction. This is why you need to check the 'specification' of the pair in your MT4 to see the swap (or use a calculator provided by your broker.) Some brokers have special rules for emerging currencies with high rates like 8%, other brokers may offer advantages for trading these depending on their business structure.
Wed to Thurs rollover is a x3 event, basically to make up for the lack of a rollover event on Sat and Sun night.
You're probably wondering why these 'small percents' matter. After all, you're in forex to make highly leveraged internet magic money, not some quarterly dividend payment like your boomer parents.
Part 3: Make America Think Again
But it's just pennies a day right, who cares?
Carry conditions can cost or credit you pennies a day or thousands of dollars a day, depending on the size of your position or the pair in play. On some pairs, you can make 15~ USD a day with just 1 lot in the market. That's over 5k a year USD. That's the equivalent of 540 pips a year, WITH 1 LOT ON 1 PAIR. And all you have to do, is fund a high rate currency bet against a low rate currency on a popular broker. That's it. No technical moonworshipping required. No stalking some coin startups social media for pump and dump schemes. No staying up all night worrying about the West going to war with Iran because you longed the Euro before dinner. It's the opposite of the coin flip, its coin printing.
Many retail traders are from developing and emerging countries, it can be an excellent opportunity for men and women of all ages. Its like working at Wall Street and sending the remittances back, all from the ease of your home; without any political, religious, cultural, or economic barriers to get in your way. Sure it's not really that convenient. But the analogy would've been really cool if it worked.
So what can happen, for example. At .40 lots for a full position, you would net 1.80 USD a day. Assuming 2 weeks to fill a position at optimal entry points (we'll talk about this later), and a remaining 2.5 month duration (5 fortnites), you net about 130 from carry credit payments during that trade period (1/4 a year), and be able to close with a very profitable or at least at a net-positive price level. Keep in mind, the average yearly takehome is anywhere from 2k-10k in developing countries. 1.8 a day can represent significant supplimentary income, and you only need 100-250 (in USD equivalent value) to support margin at most brokers. You could reinvest those winnings over the course of the first year and start the next year earning 7-8 USD a day.
Now some of you might have more cash to waste. With a career in a developed country, maybe you have 25-50k to responsibly throw around in your 20s, no family, STEM job, good rent contract, little student debt, etc. We can upgrade that position size to 4 to 8 lots. 18-37 USD per day. You'll be doubling (before tax) your initial capital every 4 years.
Part 4: Fields of Pink
But wait, what if you have the opposite position? You fund a low rate currency against a high rate currency, or your trash broker demands fees on both. Your inverted head and shoulders 4h pattern looks (and smells) great, and you're ready to long the EURUSD. You plan to hold this one for a month at least, until it hits some absolute number like 1.200 (because it's the fifth wave in some model a statistician invented 40 years ago), and therefore, must happen. You decided your 'RR' would be 3 to 1, a 150 pip stop loss and a 450 take profit. You're already taking a tendie loan out at KFC in anticipation of a big win down the line. Meanwhile, you're losing 13 dollars a day (or let's say 0.5-2 pips worth of loss), guaranteed. Because you're paying a fee to play, while taking a bet that fails at a near 50% rate (much higher for retail), while throwing away weeks/months of time in anticipation of a result/delivery (capital opportunity cost). Now, if you had ten thousand years of nutritionally deficient ancestors, I can't blame you for this decision-making. But most of us haven't.
So here it is, another forex secret:
Quite simply, there are pairs the vast majority of you shouldn't be trading, and that includes majors with poor carry conditions (losers both ways with rollover). Pairs like CHFJPY, or any pair that has you longing the JPY or CHF (and usually EUR). Betting against the USD is another insured risk, when looking at majors. It doesn't mean you should never fund a low rate against a high rate, but you need to think in terms of FEES.
Is it worth paying a daily fee to make this trade?
Now, for the greedy. You'll need to do your own research, to decide if hunting extremely high rates on emerging/exotic currencies is the best course for you and your margin, of if settling with minimal (but not negative) rates on crosses or other majors is good enough for your strategy. My guidance is to look into emerging currencies if you don't have much time to trade daily (someone with a full-time job or family) or you don't intend to sink 1,000s of hours into mastering the intra-day trade (nightmare mode).
Part 5: Washington Consensus
Trading with carry conditions in mind can even be advantageous compared to other asset classes (like stocks or corporate bonds).
It's like trading a high yield junk bond, only you have far less risk from defaults. What's a safer institution? Some 5 month-old, toothbrush-sharing, 10 slide company with 8 employees, or the full might of a nationstate?
Sure, a few nationstates have defaulted in modern history. The upside is you usually have lots of heads-up, because default tends to be political in nature. That is, if you're a nation in need of cash, you can always get a loan. It's simply a matter of if the terms are politically acceptable for your faction. This all factors into the 'heads-up' period, alerting you to pull out or reverse your position. The US tends to sanction them beforehand (conveniently) kicking you out of those markets ahead of total economic disaster. The complete opposite occurs with some shady junk bond at 15%, where the company disappears overnight. Companies fail for the smallest things, they fail all the time, and the world goes on. A country failing is always geopolitical in nature and market rules about fair play are thrown out the window. This is an intrinsic advantage to forex and global macro tradables in general.
I'll talk more about the future risk of national defaults and the utility and primacy of forex as an asset class in the final article.
So beyond the obvious consideration, which is to fund a high rate currency against a low rate; what pairs should you trade and how else could you mind carry conditions while holding a long term position? Should you stick to emerging (exotic) currencies against safe-haven currencies? IE, you only short the EURMXN or fund against the CHF? And what indicators/models (from article pt.2) should you use to achieve the safest average price entry?
Part 6: Not All Edges are Sharpe
Forex is highly volatile, so you may have an advantage in the carry conditions, but suffer a net loss from a poor initial position when you decide to close. A currency with a negative rate could move against you, bigly. Remember, the future holds unlimited risk. But the distinction here (as mentioned in the prior article), is the resilient value in understanding that contracts can have insured risk outcomes. Cost/benefits that are legally settled (from the past) at the point of opening position and at the rollover event, even if brokers tinker with the point payouts, the 'deal' is still there in some form. Here's a poorly kept institutional secret, greed often drives the price in the direction of the higher interest rate currency in a pair over multi-month periods, so this doesn't really matter. Wealthy investors are greedy for higher payouts from emerging countries: where labor is cheaper, new factories spring up all the time, and real estate can be opportune.
Part 7: Bat Soup vs the Fortune 500
Old school risk theory in markets argues that high volatility = high risk, but in recent years it has evolved beyond such mathematical explanations, especially as consecutive market challenges broke paradigms. Boomers are slow learners, but they adapt quickly when they start losing money. The subprime crisis cost them big time. And it's true today for our sniffle pandemic. It's simple: On high timeframes across longer-term positions, macroeconomics and geopolitics reign supreme. This isn't just a forex rule. This has been true since the dawn of markets in human society, it is true today, and it will be true in the end. Regulation and interest rates are variables that follow those leaders (not precede). That is, their behavior is shaped by the first two; macro and geopolitics. Think about COVID-19. Look what a few bats and one strange wet market did this world.
Macroeconomics and geopolitics produce basic patterns in the human brain that propagate through our societies as two different frequencies: the short wavelength called fear or the long wavelength called security (interpreted in complex ways by players in markets). These are filtered by timezones, languages, civilizational and organizational biases, technology, individual upbringings, and the incumbency of delusion and greed. Nanoseconds, or years later, this all gets represented as a market outcome on a chart. Amazing that people spend so much time analyzing the chaotic patterns of some shit on a floor instead of what was on the menu last night, when they try to understand what went wrong.
So if you can understand markets during these strong periods of psychological stress, and during soft periods of algorithm auctioning and market making (call it ranging), then you can sail all the seas and survive all the storms.
This is where concepts like seasonality, ATR, regressions, psychological origination, hedging, news trading, major moving averages, and others come into play.
In the coming weeks, I'll start to break down the major components of those, and where the center of price gravity and extremes are for these higher timeframe, longer-term positions. So you can find the optimal entry opportunities for longer-term trades, while also taking advantage or hedging against carry conditions. It's time to start charting the course.
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