Sell EUR/USD

I added a short EUR/USD position to my portfolio and will use that as my primary AUD/USD hedge. The USD/CAD is still open and I'm riding it until it falls out of it's channel. I have my stop placed just under the monthly 50 day moving average, or at 75% of my gains.

The EUR/USD price is 96% correlated to the AUD/USD and the periodic returns are 66% correlated. One day VaR at 0.1% is about $350. I'm holding enough excess margin for two of these but I'm going to hold off expanding for now.

Green line means long, red means short.

Analysis

The AUD/CAD trade has been constantly rising, and by way of the dollar, you can earn a positive carry. The trade looks like it is getting too hot though. DailyFX has a buy at .9420 on the AUD/CAD, and I am looking to do more heding by tightening my stops on the USD/CAD and buying the USD/EUR.

The daily charts on all parts of the AUD/CAD trade look like they're reaching a peak but the month charts show that the pairs have a lot of room to run. I am looking forward to a AUD/USD breakout similar to what is currently happening to the AUD/CAD.

Alternative Plans

I have big gains in the USD/CAD but the currency has to turn around sometime. I've locked in about half of my gains this month. When the AUD/CAD falls and takes out my stops, I will look to sell the EUR/USD and wait for the AUD/USD to take off.

Also, it is important to keep in mind that if the stock market rolls over long dollar trades will work well as people run to safety. A downward stock market move could be a big retest, or a smaller and short term bull market correction.

Oanda has a tremendous FX econometrics center that I just discovered. You can compare yeild curves, inflation trends, just about anything you can imagine for the major currencies.

I'll be testing two new brokerages in the comming weeks; FXpro and Oanda. FXpro recently won an award as Europes best FX broker. In addition to MetaTrader 4, they offer 500:1 leverage and CFD's on metals, futures, and selected equities. They're also experimenting with continuous interests payments instead of end of day swaps. I'm very excited to start testing these platforms.

Stories

U.K. economy shrinks more than expected (Bloomberg)

British economy could pull down the pound (Bloomberg)

Gold/Oil Spread

I can't tell if there is a relationship between the GLD/USO spread yet. There may be a time lag.

It should work great

The AUD/CAD just became free to hold. This means I can hold three differernt currency pairs and cancel all their price movements out. I'll be buying the AUD/USD and the USD/CAD and selling the CAD/AUD.

I took some measurements on the AUD$/$CAD portfolio and compared them to the AUD/CAD.

The long term correlation is usually strong but it broke down for two years early in the decade. For a while though, it was steady around -98%. Currently the 12 month, 6 month, and 3 month correlations are -91%, -86%, and -63%

You can see that the value of the portfolio declined from 2002 until 2005, the same time that the long term correlations fell apart and then flattened out like it should afterwards. This highlights the main risk to this type of trade.

The final chart is the distribution of values. You can see that the CAD/AUD is almost a mirror image of the AUD$/$CAD because of the distribution shifts left.

Based on one day value swings over the last two years, there is a 0.1% chance of loosing over $490 with this trade. Likewise, there is a 50% chance of no change in value and a 0.1% chance of gaining over $510.

Developing Stories

Record Correlations
Worst may be over for Treasuries
EUR/USD expected to fall

Oil and Gold

The USO appears to have strong support at 36 but it could move either direction, judging from the chart. A move to the upside is positive to the USD/CAD.

Falling gold prices this month have held the AUD/USD back. I'll be monitoring the GLD for clues on what the Aussie will do next.

FX Correlations

The coup de grâce of this blog will be the correlation calculations. I constantly track 24 major currencies for both price and daily periodic return correlations. Here are the charts.

EUR/USD, AUD/USD

The EUR/USD and AUD/USD prices are 96% correlated and their daily returns are correlated 66%. You can earn 1.56% from selling the EUR/USD and buying the AUD/USD. Returns on this trade are 34% correlated over the long term to the AUD/USD:USD/CAD trade. I need to do some more portfolio analysis before I get in.

AUD/USD Analysis

Reserve Bank of Austrialia rates: 3.00%
U.S. Federal Reserve rates: 0.25%


FXCM currently pays 1.35% or $0.37 per day per $10,000 contract.

My goal is to find a currency that will effectivly hedge away price depreciation (and appreciation) risk while earning a fair amount of carry. 1.35% does not sound like alot initially, but at 200 times leverage, it is significant.


I've identified three variables that together explain over 91% of the AUD/USD movement. They are the CAD/USD pair, the AAA corporate risk premium, and the VIX. The AUD/USD is negativley correlated to each of these variables. That is, if one goes up, the AUD/USD should fall.

The regression equation for the AUD/USD is as follows:

AUD/USD = 1.8306 -0.8354CADUSD -0.059AAARP -0.0006VIX



Comparing Prices


Comparing Periodic Returns




6 month rolling correlation AUD/USD, CAD/USD: -0.94




AUD/USD and the VIX

AAA Corporate Bond Risk Premiums

AAA Risk Premiums as functions of CAD/USD and AUD/USD

Good Morning Asia

My number one hedge, the USD/CAD, has increased it's roll to $0.02 per contract beginning this evening.

I bought the USD/CAD as a hedge against the AUD/USD on June 2. The hedge has exploded for a gain of nearly 700 pips.

FX Coverage Begins

This blog will focus on low delta, highly correlated, positive carry FX trades. I search for currency pairs that show a large degree of price correlation and a net positive interest rate differential. For example, if the AUD/USD and USD/CAD pair have been correlated to a -0.95 degree. A trader can sell both pairs and earn a positive rate of $0.65 per day per bundle on ThinkorSwim. The goal of the trade is to have one pair go up in the same ratio of the other. The net price appreciation should be zero and the carry should provide a hansom return. Based on current rates, the AUD/USD and USD/CAD bundle can return up to 150% in carry alone, depending on the amount of leverage.

Risk management is an important part of my strategy. FX markets are traded on huge amounts of leverage and while I take advantage of this to amplify the interest rate differentials, I am careful to pair my trades so they have low price risk, low portfolio volatility, and a safe amount of capital, should the spreads between pairs widen.

Check back for updates.