Hedge Fund Liquidations: Five Things You Need to Know

A great example of the herd trend in action is the "carry trade."

In the carry trade hedge funds will borrow money in a low interest currency and buy assets in a higher interest currency. For example, selling Japanese Yen (JPY) at 0.5% and reinvesting in U.S. Dollars at 3%. This trade works well as long as the exchange rate between the two currencies is stable. However, once the trade stops working (or as we say in the industry is no longer "setting up") or there is a coordinated exit from the trade, this will result in huge dislocations in the pricing of these assets without regard to the true fundamentals.

Recall the huge rally in JPY last week, as the carry trade was unwound by liquidating hedge funds. Then noticed what happened to JPY this week, once the unwinding ceased.

Your Homework

Spot market dislocations related to hedge fund liquidations, as valuations become increasingly cheap and selling seems to become irrational.

A great example of this type of dislocation was Freeport McMoRan's (FCX Quote) stock activity, which was recently subject to hedge funds liquidating en masse.

Identify when futures markets are moving by wide margins, without any associated economic or fundamental news. Instead of panicking and be shaken out of the market, use these situations in an opportunistic way.