CandleFocus Glossary Editor
Currency carry trade is a popular trading strategy in the forex market that involves borrowing low-yielding currencies to purchase high-yielding ones. It works by profiting from the difference in the interest rates of the two currencies, also known as the ‘carry’. The intention is to capture not only the difference between the currencies, but also the higher interest rate of the higher yielding currency.
Carry trades can be used to exploit two different types of carry differentials- positive carry, which when the interest rate of the currency purchased is greater than the interest rate of the currency borrowed; and negative carry, which is when the interest rate of the currency borrowed is greater than the interest rate of the currency purchased.
To implement the currency carry trade, investors need to identify the currency pairs that offer the best potential for a profitable return. This means that traders must take into account not only the fundamental economic factors of the two countries involved, but also their respective interest rates. The level at which interest rates are set is a major factor that determines the profitability of a carry trade, as a positive carry is only profitable when the difference between the two countries’ interest rates is large enough to offset the trading costs.
Once the appropriate currency pair has been identified, a trader can set up their position. This is done by borrowing one of the currencies (generally the currency with the lower interest rate) and purchasing the other currency (with the higher interest rate). The proceeds from the sale of the purchased currency are then used to repay the loan, and the remaining profits are the trader’s profits from the carry trade.
Trading the currency carry trade can be risky due to the potential for exchange rate movements to reverse and result in a loss, but with careful research and diligent risk management, this strategy can be used to generate substantial returns. It should also be noted that the carry trade should never be used to leverage capital beyond the acceptable risk levels of the investing fraternity. In this way, the currency carry trade can be a powerful tool to diversify portfolio returns and potentially generate significant returns.
Carry trades can be used to exploit two different types of carry differentials- positive carry, which when the interest rate of the currency purchased is greater than the interest rate of the currency borrowed; and negative carry, which is when the interest rate of the currency borrowed is greater than the interest rate of the currency purchased.
To implement the currency carry trade, investors need to identify the currency pairs that offer the best potential for a profitable return. This means that traders must take into account not only the fundamental economic factors of the two countries involved, but also their respective interest rates. The level at which interest rates are set is a major factor that determines the profitability of a carry trade, as a positive carry is only profitable when the difference between the two countries’ interest rates is large enough to offset the trading costs.
Once the appropriate currency pair has been identified, a trader can set up their position. This is done by borrowing one of the currencies (generally the currency with the lower interest rate) and purchasing the other currency (with the higher interest rate). The proceeds from the sale of the purchased currency are then used to repay the loan, and the remaining profits are the trader’s profits from the carry trade.
Trading the currency carry trade can be risky due to the potential for exchange rate movements to reverse and result in a loss, but with careful research and diligent risk management, this strategy can be used to generate substantial returns. It should also be noted that the carry trade should never be used to leverage capital beyond the acceptable risk levels of the investing fraternity. In this way, the currency carry trade can be a powerful tool to diversify portfolio returns and potentially generate significant returns.