Wednesday, October 8, 2008

Currency Carry Traders - They Triggered Off A Crazy Drop in AUD

Currency carry trade is a strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate.

A trader using this strategy attempts to capture the difference between the rates which can often be substantial depending on the amount of leverage the investor chooses to use.

A typical carry trade involves Yen and AUD/USD/NZD. It is a lucrative deal to borrow at low cost (in this case, Yen, at 0.5%) and use the funds to hold AUD yielding a return of 7%. This is before taking account of a good capital gain through currency appreciation.

Yen carry trades had been rampant globally in the past 5 years and that squarely explained why Yen had been notoriously undervalued against all major currencies. On the other hand, AUD benefited from carry trades and had been surging handsomely in the past few years.

A reversal trend emerged when the financial crisis broke out in U.S. which signalled that the global trend is heading down. This triggered off a sale on all major currencies by speculative funds which were the chief currency carry traders. The worst affected of all are AUD and NZD.

In a matter of less than 2 months, AUD shedded 25% from RM3.3 to RM2.5. The drop is massive and the jitters are now everywhere.

This round of slump in AUD witnessed straight breaks of resistance points which were dramatic. It struck me whenever my expected resistance was broken through.

Nonergeless, the frenzied softening of AUD has given rise to a golden opportunity to invest.

As I said sometime ago, hold on to cash as it is now the king. Don't let the crisis slip by - make sure you grab it


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