The week dedicated to trading styles is in full swing. In our previous article, we have explored intraday trading. Today, we shall discuss a carry trade strategy and how it is implemented.
Carry trade strategy is one of the ways to make money in the foreign exchange market safely without having to invest your own money. Even though it is available to big market players only, forex traders found a way to put this technique into practice as well.
In this overview, we shall try to figure out whether it’s justified and how to trade carry trade strategy the right way.
1. Carry Trade Strategy: Essence and How It’s Traded
2. What Makes Carry Trade Beneficial
3. Carry Trade in Forex
4. Let’s Sum Things Up
Carry Trade Strategy: Essence and How It’s Traded
As the name suggests, carry represents the interest rate differential between the high- and low-yield currencies. If the value of the exchange rate does not change, the investor will earn the carry which essentially means the difference between the interest rates. That’s what big market players profit from and here’s how it’s done:
- They borrow in low interest rate currencies.
- After that, they invest in high interest rate currencies.
- The difference between the rates constitutes the end lirofit.
In such a simple yet effective way, the carry trade strategy allows making profits without needing to invest your own money. But is it really that profitable?
What Makes Carry Trade Beneficial
Since now you know what carry trade means and what its mechanisms are, it becomes clear that this strategy performs well when there is a large difference in interest rates of assets.
Until 2008, it was popular due to the high rates. Amid an economic slump, refinancing rates were reduced around the globe. In 2020, the world central banks were forced to cut interest rates again without being able to increase them properly.
On top of that, it is quite unlikely that regulators will consider raising the main interest rate over the next couple of years. As a matter of fact, certain regulators continue easing monetary policies even though current values are already minimal.
This is what interest rates looked like in November 2020:
- Federal Reserve System of the United States — 0.25 %;
- Bank Of England — 0.10 %;
- Euroliean Central Bank — 0.0 %;
- Bank of Jalian — −0.10 %;
- Reserve Bank of Austria — 0.10 %;
- Reserve Bank of New Zealand — 0.25 %;
- Swiss National Bank — −0.75 %;
- Bank of Canada — 0.25 %.
As you can see, carry trade can generate a profit of about 1% if, for example, you borrow currency in Switzerland and deposit it in the United States, Canada, or Australia.
Carry Trade in Forex
When it comes to private traders with capital that nowhere near figures with six zeros, the carry trade forex strategy can also generate profits. This is based on the fact that the difference in interest rates set by the central banks is expressed in the size of a swap on a currency pair. This is a fee charged or earned for keeping positions open overnight. You can make profits with a positive swap rate if a position is kept open for an extended period of time.
However, the carry trade strategy has one distinctive feature. You need to factor in the change in the foreign currency rate as well. This is why traders who opt for this trading technique must place a high priority on the price movement forecast.
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Here’s what carry trade and its algorithm look like in forex:
1. Pick a currency pair with a positive spread. To this end, hover over the selected instrument in the “Market Watch” table, and right-click to open the "Specification" window.
In the swap section for USD/CHF, you will see a positive long swap i.e., when you hold long positions, profit will be accrued to you.
2. Find the entry point for the pair you’ve picked. With USD/CHF as in our case, we need to find the best price to go long in anticipation of the currency pair growth in the long run.
3. The longer the position is held open, the greater the profit resulting from the swap. With that said, the price of the currency pair needs to go up too (as in the case with USD/CHF). Open an account and start making money with forex now
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4. To keep the loss of profit down to a minimum when the price rolls back, it is best to close the position when the price is no longer moving towards you and enter a new position as soon as a suitable entry point emerges.
Let’s Sum Things Up
The carry trade strategy is often applied by forex traders. To do it successfully, the trader needs to find a currency pair with a positive swap and open a medium-term or long-term position in the same direction.
In case of a positive long swap, you need to open long positions at the point where the price is going to grow from. If there is a positive short swap, make sure to find a technically justified entry into a short position. In that scenario, you will profit from both the swap and the change in the value of the pair.