Carry Trade Forex Strategy
Carry trade strategies can be a stable and effective way to increase your chances of generating a return. Essentially, the carry trade is a quirk of the forex currency pairing system where traders are effectively going long on one currency and short on another at the same time. Interest is paid and charged on long and short positions respectively at the central bank interest rates of the currency pair you are trading, and the difference in between will present a daily profit to the trader if all things remain equal.
If the market moves up, these returns will increase even further because there will be a capital growth in the position as well as the ongoing daily interest yield. With some currency pairings, for example AUD/JPY, the differential between interest rates is traditionally one of the most significant, with the potential to deliver a 5% annual yield. On transaction sizes that are leveraged up even as much as 200:1, this represents a 1000% annual return if the market stays static. The risk is of course that interest rates converge, or that the market falls over the period.
What You’re Looking For
In order to make this work, you need to find currency pairings that have a high interest rate differential. The greater the difference between the interest rates, the more juicy the margin you’re likely to receive. At the same time, this strategy is no good in a falling market. Remember you’re going for static or better – essentially this means you have to plug into a market that is generally trending upwards, which will also provide you with capital growth as an added bonus over time. Less volatile markets are arguably better here, because this is a long-term strategy that seeks to exploit interest rates to the fullest.
Which Trader Does This Suit
This suits the longer-term forex trader with capital to tie up best. Because interest rates are worked out on an annual basis, albeit applied daily, the longer a position is held the greater the differential return will be. For traders looking to get involved in fast-paced, action packed trading this isn’t it – but for those interested in a risk-controlled return they can see substantial returns over time in growing markets. With both a yield and the prospect of capital growth, this kind of trading is designed to generate decent returns over a longer period of time and therefore considered best suited to more stable markets and positions.
Strengths and Weaknesses
The obvious strengths here are the fact that it takes much of the risk out of trading on a more short term basis, and much of the legwork to boot. Assuming you take care to ensure that the market doesn’t fall away during the period of your trade, it can be a solid way to generate vast returns over a longer time frame. While that is evidently an attractive feature for a number of traders, this must also be balanced with the risk of a decline in the market. This is something that you can’t really guard against, so you should be prepared and ready to anticipate factors which might influence the market adversely and end up costing you your position and your earnings from it.