Starting with a small deposit of $69.10, supporting a short position of 210 USD/TRY, my intention is to increase the value of my carry positions each year in such a way that the initial interest income of $1.05 per month grows to approximately $1000 per month over the course of 10 years. The simplest way of doing this would simply be to let the interest income of (initially) 6% support an additional 100% in position size, but this would require leverage of about 16:1 for the entire period which is far too risky. The key to the success of this strategy will be mitigation of risk through the following methods:

1. Diversification: Initially I'll be building positions in the Turkish Lira, the Hungarian Forint, and the South African Rand. This helps to lower the risk that a destabilizing event in one part of the world will move the entire carry portfolio into a margin call.

2. Front loading of leverage: I will be increasing the size of the positions more quickly during the early years when the amounts involved are low. Using the highest leverage during this period means that any additional margin deposits necessary due to adverse moves will be affordable. There are details on this below.

3. Trading around the core position: When the position size is smaller than its projected size at a given time, I will add to the position more quickly when it is at a loss and more slowly when it is in profit. Conversely, when the position size is larger than projected, I will reduce it more quickly when it is profit, and more slowly when it is at a loss. This contrarian approach will tend to move my average entry price in a favorable direction over time. There is a simple formula for doing this, details of which are below.

NOTE: The following section may change from time to time, including the projections in the Excel table. Whenever I change the projections, I start at the current month, which is why the earliest months in the 10-year period are blank.

Front loading of leverage means that I want to have my greatest risk during the earliest period in the account building process, and to lower that risk as time goes on and the account gets larger. After some experimentation, I decided to start with a margin percentage of 15% and to increase that by 1/10 percent each month to about 27% after 10 years.

Given an initial position size, an assumed interest rate differential income of 6% and a deposit of a certain size, I can project a cash balance for each month. Dividing that balance by the margin percentage for that month gives me the projected position size. Below is a chart showing the resulting margin percentage and monthly income stream, along with the actual projections upon which the chart is based.

Obviously these projections are based on simplified assumptions such as the interest differential between all carry currencies and the USD remaining at 6% which certainly won't happen. If anything however, I expect those differentials to increase as the world emerges from recession and begins to raise rates to ward off inflation.

I think that covers the concept of front loaded leverage, so let's move on to the method of trading around the core positions. On the first day of any given month during the 10 year buildup period, there is a specific projected position size, which can be found in the projection table above. It's a fairly simple exercise to interpolate what the value should be on any day during the month as well.

The simplest growth method then would simply be to add to the positions periodically so as to keep to the schedule. However, I will be attempting to take advantage of price fluctuations to get a better average entry price over time. The way to do this is to add to the positions more quickly during periods when they are at a loss, because prices are more favorable then. During periods when the positions are at a profit, I will be adding more slowly. Conversely, if I am attempting to reduce my position sizes down to the projected value, I'll do this more quickly when they are at a profit, and more slowly when they are at a loss. The formula for accomplishing this is:

Order = (deposit/equity)*(projected position) - (actual position)

As an example, suppose I have an actual position size of $2000 and a projected position size of $2500 dollars at a given point in time. My goal is to increase my position size by $500. But suppose I'm deep in profitable territory, meaning that prices are not very favorable now. If my cash deposit is $450 and my equity is $500, the formula above would yield:

($450/$500)*$2500 - $2000 = $2250 - $2000 = $250

So in this situation I would actually place an order to add only an additional $250 to my position at these prices; not $500. Note that in extreme situations the direction of the order can actually be reversed. If the size of my cash base (deposit) in the above example were only $350, we would have:

($350/$500)*$2500 - $2000 = $1750 - $2000 = -$250

In this case I would actually be reducing my position size even further from its projected size on this date because taking profits is so lucrative. Over time of course the increasing projected position size will force me to keep adding to the position over the long term in order to keep to the growth schedule, but in the short term I hope to accumulate some additional trading profits with this method.

I will not be placing market orders for this purpose. Instead, I'll be placing stop orders "behind" the price as it moves in a given direction. For example, if I have a sell order to place, I would place it only when the daily bars are making higher lows, and place the order behind those lows, moving it up behind the price in order to lock in a better price when it finally fills. Essentially, I'm just using trailing stops for both entry AND exits.

EDIT -- SEPTEMBER 2011

A very large drawdown from this period has drawn my attention to the requirement for strict risk control measures on the account. Thus, there is one further rule that I will be following from this point on, which is to maintain my position size between 4 and 8 times equity. So, when the market is moving against me strongly, I will eventually get to a point where I cannot continue to add to positions while maintaining my position inside these boundaries. At that point I would actually be reducing my position to control risk. This keeps me from getting into a crazy martingale situation and getting wiped out by a large move. Conversely, when the market is moving in my direction, I would actually be in the enviable position of having to add to my positions as my profit grows. Unlike normal periods in which I trail stop orders for both entries and exits, these "margin rule" orders will always be immediate market orders.

That's the complete carry trade strategy. The table at the top of the home page provides a summary of the current situation, showing the key variables required for the calculation of the order sizes. For examples of the strategy in operation, just follow my blog entries on the main page. Stay tuned, and keep pipping up!

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