Carry Trading in Forex
Carry trading is done by forex traders to take benefit of the basic economic fact that money will flow where it will get high returns. This constant flow of capital between the different markets is what makes carry trading possible.
Carry trading is quite popular among professional forex traders. Hedge funds and investment banks also do leveraged carry trading to make profits. You as a retail forex trader can also benefit from carry trading.
What is a carry trade? In nutshell, carry trading means taking advantage of interest rate difference between two currencies in a currency pair. Investors take benefit of the interest rate differential between two currencies by going long/buying the high interest rate currency and going short/selling the low interest rate currency.
Lets take an example: suppose New Zealand dollar offers an interest rate of 4.75% while the Japanese yen offers an interest rate of 0.25%.
An investor who wants to capitalize on this interest rate differential will buy New Zealand dollars (NZD) and sells Japanese Yens (JPY). The investor can earn a profit of 4.75-0.25=4.5% as long as the NZD/JPY exchange rate does not change. If the investor uses a leverage of 10:1, this 4.5% return will be magnified into 45%.
If the currency pair NZD/JPY appreciates, the investor can get a capital gain as well as a yield on the investment. When there is a carry trade opportunity, many investors jump on the bandwagon. The more investors carry trade, the more the currency pair appreciates.
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.
When an investor enters into a carry trade, an investor expects to profit from an interest rate difference between a currency pair. But in case, low interest currency appreciates considerably for different reasons, carry trade will become unprofitable.
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.
You can use the MACD (moving average convergence divergence) indicator to identify the trend. - 23222
Carry trading is quite popular among professional forex traders. Hedge funds and investment banks also do leveraged carry trading to make profits. You as a retail forex trader can also benefit from carry trading.
What is a carry trade? In nutshell, carry trading means taking advantage of interest rate difference between two currencies in a currency pair. Investors take benefit of the interest rate differential between two currencies by going long/buying the high interest rate currency and going short/selling the low interest rate currency.
Lets take an example: suppose New Zealand dollar offers an interest rate of 4.75% while the Japanese yen offers an interest rate of 0.25%.
An investor who wants to capitalize on this interest rate differential will buy New Zealand dollars (NZD) and sells Japanese Yens (JPY). The investor can earn a profit of 4.75-0.25=4.5% as long as the NZD/JPY exchange rate does not change. If the investor uses a leverage of 10:1, this 4.5% return will be magnified into 45%.
If the currency pair NZD/JPY appreciates, the investor can get a capital gain as well as a yield on the investment. When there is a carry trade opportunity, many investors jump on the bandwagon. The more investors carry trade, the more the currency pair appreciates.
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.
When an investor enters into a carry trade, an investor expects to profit from an interest rate difference between a currency pair. But in case, low interest currency appreciates considerably for different reasons, carry trade will become unprofitable.
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.
You can use the MACD (moving average convergence divergence) indicator to identify the trend. - 23222
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 @ 4:53 AM
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