Exchange traded funds continue to increase in number and popularity, growing to one of the most commonly traded securities on the stock exchange as both institutional and the average retail investor gain greater access to broad or specialized market exposure. Yet many individuals are unfamiliar with ETFs’ inner workings. In this ongoing series, we hope to address your questions and help shed light on the investment vehicle. [What is an ETF? — Part 16: Inverse and Leverage Funds]
In a previous installment, investors learned about ways to access the vast, liquid currency foreign exchange market through exchange traded products. While investors may make the obvious choice in taking long or short positions in world currencies, traders can also capitalize on the differences in interest rates between various countries with the “carry trade” technique.
The carry trade strategy is where a currency trader sells a currency with a low interest rate and uses the the profits to buy another currency with a higher interest rate, capitalizing on the difference between rates. As such, the currency ETF trader is expected to follow a type of long/short strategy. [Inverse and Leverage Funds]
In utilizing the carry trade strategy, currency traders apply the same “buy low” and “sell high” concept, except with various country’s yields. Consequently, most carry trades are done with currency pairs.
Potential traders would mix and match low yielding currencies, like the British pound, Canadian dollar, U.S. dollar, Swiss franc and Japanese yen, with a high yielding currency, such as the Australian dollar or the New Zealand dollar.
For instance, the Australian dollar with the Japanese yen or the New Zealand dollar with the Japanese yen are two of the most popular methods to utilize the carry trade. Japan has historically held very low interest rates, which, as of June 2, were at about 0.10%, whereas Australia had a 3.5% rate and New Zealand had a 2.5% rate. [World Currencies]