Carry Trading in Forex
In currency markets, carry trading is done by many investors to take benefit of the basic economic principle that money flows where the returns are high. This constant flowing in and out of capital between the different markets is what makes carry trading profitable.
Carry trading is one of the fundamental trading strategies employed by professional forex traders. Leveraged carry trading is one of the favorite strategies employed by hedge fund and investment banks. You as a forex trader can also benefit from carry trading.
Carry trading means taking benefit of the interest rate difference between two currencies. Carry traders take benefit of the interest rate differential between two currencies by buying or going long on the high interest rate currency and selling or going short on low interest rate currency.
Lets use a simple example to make it clearer: lets assume, New Zealand dollar is offering an interest rate of 4.75% whereas the Japanese yen is offering an interest rate of 0.25%.
In order to carry trade, an investor buys New Zealand dollars (NZD) and sells Japanese Yens (JPY). As long as the exchange rate between the NZD and JPY does not change, the investor will earn a profit of 4.75-0.25=4.5%. Using a leverage of 5:1, this 4.5% return will be leveraged into 22.5%.
Another thing that can go in favor of the investor is if the currency pair NZD/JPY appreciates, he/she can get capital appreciation as well as a yield. Many times, appreciation will also happen as many other investors also jump on the bandwagon when they see a good carry trading opportunity.
However, carry trading depends a lot on the mood of the investors as a group. When investors have low risk aversion, carry trades will be profitable. But suppose the investors as a group suddenly develop high risk aversion and run to take refuge in safe haven currencies. In this scenario, carry trading will become unprofitable.
However, if the low interest currency appreciates to some extent for different reasons, carry trade will become unprofitable. In such a scenario, the more the low interest currency appreciates, the more unprofitable carry trading that currency pair will become.
So it essential when you determine a currency pair for carry trading, you also identify the current trend of the currency pair to see whether it is moving in the right direction.
MACD (moving average convergence divergence) indicator can help you in this regard. You should enter the trade when MACD crosses the zero line from below. You should exit the trade when it crosses the zero line from above. - 23200
Carry trading is one of the fundamental trading strategies employed by professional forex traders. Leveraged carry trading is one of the favorite strategies employed by hedge fund and investment banks. You as a forex trader can also benefit from carry trading.
Carry trading means taking benefit of the interest rate difference between two currencies. Carry traders take benefit of the interest rate differential between two currencies by buying or going long on the high interest rate currency and selling or going short on low interest rate currency.
Lets use a simple example to make it clearer: lets assume, New Zealand dollar is offering an interest rate of 4.75% whereas the Japanese yen is offering an interest rate of 0.25%.
In order to carry trade, an investor buys New Zealand dollars (NZD) and sells Japanese Yens (JPY). As long as the exchange rate between the NZD and JPY does not change, the investor will earn a profit of 4.75-0.25=4.5%. Using a leverage of 5:1, this 4.5% return will be leveraged into 22.5%.
Another thing that can go in favor of the investor is if the currency pair NZD/JPY appreciates, he/she can get capital appreciation as well as a yield. Many times, appreciation will also happen as many other investors also jump on the bandwagon when they see a good carry trading opportunity.
However, carry trading depends a lot on the mood of the investors as a group. When investors have low risk aversion, carry trades will be profitable. But suppose the investors as a group suddenly develop high risk aversion and run to take refuge in safe haven currencies. In this scenario, carry trading will become unprofitable.
However, if the low interest currency appreciates to some extent for different reasons, carry trade will become unprofitable. In such a scenario, the more the low interest currency appreciates, the more unprofitable carry trading that currency pair will become.
So it essential when you determine a currency pair for carry trading, you also identify the current trend of the currency pair to see whether it is moving in the right direction.
MACD (moving average convergence divergence) indicator can help you in this regard. You should enter the trade when MACD crosses the zero line from below. You should exit the trade when it crosses the zero line from above. - 23200
About the Author:
Mr. Ahmad Hassam is a Harvard University Graduate. He is interested in day trading; stocks and forex. Read about Trend Forex System. Best Forex Signal Service. Learn Forex Trading.
posted by X - Men @ 4:59 AM
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