What is the Carry Trade?
Carry Trade is a particular investment method that is applicable to the Forex market and that doesn’t really use a movement in the rates. To apply this method you essentially need to take into account the interest rates of currencies.
Basically this consists of buying a currency at a weak rate of interest and investing the funds obtained in a currency that offers the opposite, a strong rate of interest. It is therefore through the difference between these two rates of interest that your profit will be made.
How to use Carry Trade:
When trading on the Forex, this basically means buying one currency and selling another. In this way you will pay interest on the currency sold and receive interest on the currency purchased. Basically, every evening, at the end of the trading session, your broker will credit your account with the difference between the interest rates on the trades completed during that day.
But be careful! To correctly manage your Carry Trade you should still take into account the other factors that could influence the currency pairs on the Forex. In fact, during your transaction the rate can move in the direction that does not correspond with your position and that could lead to losses that are greater than your profit on the interest rates.
Another thing, do not forget that your online broker will deduct spreads on each of your transactions. These amounts should also be taken into consideration in your profitability calculations.
Let’s take a simple example to better understand this technique:
Let’s imagine that X currency has an interest rate of 0.5 % and Y currency has an interest rate of 5%. By borrowing funds from X currency to buy Y currencies, your gain will therefore be the difference between the borrowing price and the purchase price. Therefore 4.5 -0.5 = 4%.
If the Carry Trade method is mainly applied on Forex, it is because this profit remains very low on the other markets that do not have a significant leverage effect.
Some tips for applying this method:
To avoid the risks associated with the Carry Trade strategy and ensure significant gains when you speculate with this method on Forex, you should check some essential points. On one hand, avoid applying this technique on a currency pair that shows too much volatility unless you pair your intervention with a technical analysis that allows you to maximize your profits. In case you manage to accumulate profits made in a traditional way and those resulting from interest rate differentials, you will have large gains. But if, on the contrary, you lose with the change of the asset price, this can largely compromise your gains.
- Firstly, you should identify a currency pair that shows an interesting differential in the rate of interest, that is to say higher than 3%. You should know for example that the Yen has a weak interest rate and is often used by Carry Traders.
- Then, you should ensure that this currency pair moves in the direction of your operation over a long term trend, or that this currency pair does not show a pronounced trend and moves within your trading range.