Carry Trade Strategy Guide

The carry trade is one of the oldest and most popular forex strategies. The idea is simple: you borrow in a low-interest currency and invest in a high-interest currency.

What Is A Carry Trade?

In a carry trade, you sell a low-interest currency (the funding currency) and buy a high-interest currency (the target currency). You earn the interest rate differential, also called "swap" or "rollover."

How It Works

Example

Suppose you sell JPY (Japanese Yen, low interest) and buy AUD (Australian Dollar, high interest). Each day you hold the position, you receive interest on the difference.

Interest Rate Differential

The larger the interest rate differential between the two currencies, the more you earn. But note: a larger differential often means more risk.

Risks of Carry Trades

1. Exchange Rate Risk

The biggest risk is that the exchange rate moves against you. A small decline in the target currency can quickly wipe out your interest earnings.

2. Interest Rate Changes

Central banks can change their interest rate policy. A rate cut by the target currency's central bank can undermine your strategy.

3. Market Sentiment

In times of market turmoil, carry trades are quickly unwound. Investors seek safety, leading to a strong appreciation of the funding currency.

Tips for Carry Trading

• Choose currencies with a stable interest rate differential
• Take exchange rate risk into account
• Use a stop loss
• Follow central bank policies

Conclusion

The carry trade is an interesting strategy for traders willing to hold positions for a long time. It offers an extra source of income alongside the price movement.