Taking advantage of carry trade means buying a higher-yielding currency against a lower-yielding one. This means that you earn from the positive interest rate differential when you buy a currency that offers higher interest and short a currency that offers lower interest. This will allow you to make profits as you hold on to the trade for days even if there's not a lot going on in price action.
For example, you can buy the Australian dollar against the euro and earn a positive interest rate differential of 2%. Of course this assumes that the RBA gives an interest rate of 2.50% and the ECB is currently offering an interest rate of 0.50%. Using the right account size and enough leverage, plus the number of days you hold on to the trade, you can enjoy compounded interest also.
What really happens with your broker is that they close positions at the end of the day and reopen them the next day for as long as you haven't exited the trade. This happens very quickly so you won't really witness it on your trade platform. In effect though, the interest for the day gets added or subtracted from your account, depending on your trade position.
Carry trade can work against you too if you are short a position on a higher-yielding currency versus a lower-yielding one. For example, if you are selling New Zealand dollars in exchange for U.S. dollars and you held on for a day, you get a -1.50% return since the RBNZ gives a rate of 2.00% while the Fed has 0.50%.
Remember also that risk sentiment must be on your side when taking advantage of carry trades. This means that market sentiment should be favoring a rally of higher-yielding currencies versus lower-yielding ones, as traders would rather take on more risk. This way, you can have positive returns from your forex trade and add to your wins with the positive interest rate differential. On the other hand, when risk is off and higher-yielding currencies are selling off, you can still earn from positive carry but lose on your forex trade.
To summarize, there are two major things you need to look for to profit from carry trade. First is the positive interest rate differential in buying a higher-yielding currency versus a lower-yielding one. Second is risk appetite, which should keep the higher-yielding currency rallying against the lower-yielding one.
For example, you can buy the Australian dollar against the euro and earn a positive interest rate differential of 2%. Of course this assumes that the RBA gives an interest rate of 2.50% and the ECB is currently offering an interest rate of 0.50%. Using the right account size and enough leverage, plus the number of days you hold on to the trade, you can enjoy compounded interest also.
What really happens with your broker is that they close positions at the end of the day and reopen them the next day for as long as you haven't exited the trade. This happens very quickly so you won't really witness it on your trade platform. In effect though, the interest for the day gets added or subtracted from your account, depending on your trade position.
Carry trade can work against you too if you are short a position on a higher-yielding currency versus a lower-yielding one. For example, if you are selling New Zealand dollars in exchange for U.S. dollars and you held on for a day, you get a -1.50% return since the RBNZ gives a rate of 2.00% while the Fed has 0.50%.
Remember also that risk sentiment must be on your side when taking advantage of carry trades. This means that market sentiment should be favoring a rally of higher-yielding currencies versus lower-yielding ones, as traders would rather take on more risk. This way, you can have positive returns from your forex trade and add to your wins with the positive interest rate differential. On the other hand, when risk is off and higher-yielding currencies are selling off, you can still earn from positive carry but lose on your forex trade.
To summarize, there are two major things you need to look for to profit from carry trade. First is the positive interest rate differential in buying a higher-yielding currency versus a lower-yielding one. Second is risk appetite, which should keep the higher-yielding currency rallying against the lower-yielding one.
About the Author:
Learn more about positive carry. Stop by Steve Hall's site where you can find out all about forex trading.
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