There are many different ways to look at trading the forex, and while each trader will have his or her own strategies for getting ahead in the market, carry trades are one type of currency trading that have a large following. A carry trade strategy allows us to make a profit even when the market is stable as it does not rely on the movement of pricing between two currencies. Instead, the success of a carry trade depends upon the difference between the interest rates of two separate currencies.
A carry trade involves borrowing or selling a financial instrument with a low-interest rate, then using it to purchase a financial instrument with a higher interest rate. While you are paying the low-interest rate on the financial instrument you borrowed/sold, you are collecting higher interest on the financial instrument you purchased. So your profit is the money you collect from the interest rate differential. This interest is added into the profits or added to offset the loss in any carry trade on the forex market.
A carry trade strategy is only fit for a sideways moving market. We must anticipate the movement of the price and only trade if the price is expected to remain more or less the same. Of course, the most profitable way to carry trade forex pairs is to combine it with other trading strategies. By selecting to enter a trade where we stand to profit from both price movement and from the differences in interest rates, we are able to maximize our shot at sustaining profit.
Currency carry trades can be made with simple cash transactions involving the purchase of foreign currencies. However, according to the Bank for International Settlements (BIS), they are most frequently made through derivatives market operations, including futures, forwards, forex swaps and options. Also, they are often made over a period of 6 months or less.) The common strategies of carry trade that the BIS identifies includes a direct acquisition of debt in a high-interest-yielding currency using borrowed funds in a low-interest currency. At settlement, the investor sells the debt and repurchases the funding currency to repay the initial amount borrowed.
Like any other trading strategy, use proper risk management, and use your head when making trades. It becomes tempting to reach out for that daily interest payment, but without some caution, that small payment could cost you a fortune in losses. It is best to combine carry trading with supportive fundamentals and market sentiment. Carry trades work best when the market is “feeling safe” and in a positive mood. Properly executed carry trading can add substantially to your overall returns.