Profit From the Carry Trade in Currency Trading

If you propose to trade currency for the longer term, such as I do, rather than as a scalper who trades the market hundreds of times as day, then a key element to your success will be in understanding the carry trade. This provides trading opportunities due to the difference in interest rates between the various currencies.

Each country and therefore currency has its own interest rate, which is then converted into borrowing and lending rates by all the banks. When a bank lends you money the rates are always higher than when it borrows (like a spread). It pays you a lower rate on your funds deposited, than it charges you to borrow! Now, obviously rates between countries vary enormously. The interest rate in Japan is currently near 0%, and the New Zealand central bank rate is 7.25%, the Swiss is currently 2.0%, the Eurozone 3.5%, UK 5.25%, and the US at 5.25% Now the variation in currency from country to country allows us to use interest rates to our advantage in longer term trading.

If we take an example as follows: suppose we decide to buy the USD/JPY currency pair. With a BUY order we are long in US dollars (bought) and are short the Japanese Yen. Over a twenty four hour period on 10,000 dollars we might look to make $1.10 every 24 hour period. Now if we assume that you are trading at a leverage of 100:1, you are effectively earning 1.10 USD on 100 dollars for one day on a buy order. For a month of trading this would equate to 33 USD on 100 dollars - not a bad rate of return!!! With a carry trade we always buy the higher interest rate currency and sell the lower interest rate for a positive carry. Using the carry trade is a great way to earn excellent rates of return on your trades, along with a profit on the actual trade itself – and remember if the trade goes in the opposite direction, at least you are earning money on the trade. The longest I have held a carry trade is nearly 15 months.

In using carry trades, always use the major crosses, never any of the exotics, and always remember that if you are looking at a carry trade possibility, so is the rest of the world. After all we all look at the same charts and prices!! Also remember that what may have been a great carry trade last year may not be so great this year – interest rates can and do change so check the carry trade yield before you enter the trade!!