If you want to be able to benefit from carry trade, you simply have to buy a higher-yielding currency versus a lower-yielding one. In effect, you are holding on to a currency with a higher interest rate and selling the one that has the lower interest rate. With that, you can be able to profit from the interest rate differential alone even if price action remains steady for a few days.
For example, you can buy the Australian dollar against the euro and earn a positive interest rate differential of 2%. Of course this assumes that the RBA gives an interest rate of 2.50% and the ECB is currently offering an interest rate of 0.50%. Using the right account size and enough leverage, plus the number of days you hold on to the trade, you can enjoy compounded interest also.
Holding on to a trade for more than a day means that brokers have to close and reopen your trade, even if you don't see this actually happening right on your platform. In this process, the interest rolls over to the next day and gets debited to or credited from your account.
As you probably noticed, carry trade can also work against you if you short a higher-yielding currency against a lower-yielder. For instance, you can short New Zealand dollars against U.S. dollars and you could incur -1.50% on your account. This is because the RBNZ currently has 2.00% interest while the Fed gives 0.50% only.
Carry trades tend to work best when risk appetite is on and traders are buying up higher-yielding currencies. This means that you get to earn from the trade itself as you are also long on the higher-yielding currency plus you also earn from the positive carry. On the other hand, when risk is off and traders are short higher-yielding currencies, you still have a chance to earn from positive carry but the gains will be offset by your losing forex trade.
At the end of the day, there are two things you need to remember when trying to take advantage of carry trade. One is that you need to look for a currency that offers higher returns and buy it against another currency that offers lower returns. Two is that you have to make sure that risk taking is on so that you reap benefits from your winning forex position along with the positive carry.
For example, you can buy the Australian dollar against the euro and earn a positive interest rate differential of 2%. Of course this assumes that the RBA gives an interest rate of 2.50% and the ECB is currently offering an interest rate of 0.50%. Using the right account size and enough leverage, plus the number of days you hold on to the trade, you can enjoy compounded interest also.
Holding on to a trade for more than a day means that brokers have to close and reopen your trade, even if you don't see this actually happening right on your platform. In this process, the interest rolls over to the next day and gets debited to or credited from your account.
As you probably noticed, carry trade can also work against you if you short a higher-yielding currency against a lower-yielder. For instance, you can short New Zealand dollars against U.S. dollars and you could incur -1.50% on your account. This is because the RBNZ currently has 2.00% interest while the Fed gives 0.50% only.
Carry trades tend to work best when risk appetite is on and traders are buying up higher-yielding currencies. This means that you get to earn from the trade itself as you are also long on the higher-yielding currency plus you also earn from the positive carry. On the other hand, when risk is off and traders are short higher-yielding currencies, you still have a chance to earn from positive carry but the gains will be offset by your losing forex trade.
At the end of the day, there are two things you need to remember when trying to take advantage of carry trade. One is that you need to look for a currency that offers higher returns and buy it against another currency that offers lower returns. Two is that you have to make sure that risk taking is on so that you reap benefits from your winning forex position along with the positive carry.
About the Author:
Learn more about positive carry. Stop by Steve Hall's site where you can find out all about forex trading.
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