A Tip From The World's Biggest Currency Trader
By Tom Dyson
May 10, 2007
Bill Lipschutz had a problem: "I was really scared. I remember thinking: This is the bullet that finally catches me in the back of the head."
It was the fall of 1988. Gorbachev had just announced a Soviet troop reduction, and the U.S. dollar was rallying. Bill Lipschutz had taken a $3 billion position against the dollar. It took just eight minutes for the position to lose $90 million... and now he was trapped, unable to close it.
"All I wanted to do was make it through to the Tokyo opening at 7 p.m. for the liquidity," Lipschutz says. "If you really have to buy $3 billion, you can do it in Tokyo; you can't do it in the afternoon market in New York."
Lipschutz told his boss the bad news. His boss stayed calm. "Do what you need to do" was all he'd said...
On this occasion, Lipschutz got lucky. The dollar reversed when the Tokyo market opened. He escaped with a loss of just $18 million.
Lipschutz was the largest currency trader in the world during the 1980s. In his eight-year career with Salomon Brothers, he generated more than half a billion dollars in profits by trading currencies. I found this story about him in New Market Wizards by Jack Schwager.
Today, we're following Lipschutz's lead to place a currency trade...
"It is well acknowledged that the most profitable market environment for FX [foreign exchange] trading is a trend – in particular a trend that unfolds over a medium- to long-term time horizon," Lipschutz says in a recent magazine article.
Lipschutz identifies these trends and then tries to ride them to their conclusion. The problem is, while it sounds easy, it's not, even for a pro like Lipschutz. "A key to profiting from a trend is the ability to stay in the trade and not be shaken out during periods of price consolidation or correction, " he says.
So what's Lipschutz's secret? He calls it "holding positive carry" and says it makes it easier to stay in the trade. Let me explain:
When you make a currency bet, you exchange one currency relative to another. Often, the two currencies will have different interest rates. To "hold positive carry," all you have to do is exchange a currency with a low interest rate for a currency with a high interest rate...
We wrote about Icelandic bonds yesterday... and how they yield more than 11% right now.
Well, Iceland's currency carries a 12% yield. If you live in the U.S., your bank will pay you around 5% for depositing your money in dollars. But if you exchange them for Icelandic krona, you'll get 12%. In other words, you are now holding a 7% carry. Think of it as an incentive from Iceland to encourage you to invest in their currency.
On the flip side, if an Icelandic citizen wanted to invest in dollars, he'd have to pay a 7% carry while he held his position. It's a bit like the dividend on the stock. When you buy the stock, you receive dividends. But when you sell the stock short, you must pay dividends. The difference is, in the currency market, your broker won't pay you a check for the carry. It's more like an invisible tailwind (or headwind) to your position.
With this strong tailwind, you can see why it's really easy to bet on Iceland's currency. Not only do you start your position with a 7% cushion, but the tailwind attracts other investors, which will support the krona's exchange rate.
In sum, Bill Lipschutz was the biggest currency trader in the world. If he pays so much attention to the carry, we should too.
Good investing,
Tom
P.S. Steve says Iceland is the safest place to do business in the world. If you're interested in that high yield, you should check out the special report we made for DailyWealth subscribers...
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