Forex Trading Advanced Level Course
    About Lesson

    Carry Trade

    A carry trade involves borrowing or selling a financial instrument with a low-interest rate and then using it to purchase a financial instrument with a higher interest rate. While paying the low interest rate on the financial instrument you borrowed/sold, you are collecting higher interest on the financial instrument you purchased. So, your profit is the money you order from the interest rate differential.

    Carry Trade Example:

    Let’s say you go to a bank and borrow $10,000. Their lending fee is 1% of the $10,000 every year. You purchase a $10,000 bond with that borrowed money that pays 5% a year. You made 4% a year! The difference between interest rates!

    Currency Carry Trade

    In the forex market, currencies are traded in pairs (for example, if you buy USD/CHF, you are buying the U.S. dollar and selling Swiss francs at the same time). You pay interest on the currency position you SELL and collect interest on the currency position you BUY.

    What makes the carry trade special in the spot forex market is that interest payments happen every trading day based on your position. Technically, all positions are closed in the spot forex market at the end of the day. You don’t see it happen if you hold a position the next day.

    Brokers close and reopen your position, and then they debit/credit you the overnight interest rate differential between the two currencies. This is the cost of “carrying” (also known as “rolling over“) a position to the next day. The leverage available from forex brokers has made the carry trade very popular in the forex market. Most forex trading is margin-based, meaning you only have to put up a small amount of the position, and your broker will put up the rest. Many brokers ask as little as 1% or 2% of a position.

    When Do Carry Trades Work?

    Carry trades work best when investors feel risky and optimistic enough to buy high-yielding currencies and sell lower-yielding currencies. Know When Carry Trades Work and When They Don’t. It’s like an optimist who sees the glass half full. While the current situation might not be ideal, he hopes things will improve. The same goes for carry trade.

    Economic conditions may not be good, but the buying currency’s outlook needs to be positive. If the outlook of a country’s economy looks as good as Angelina Jolie’s or Brad Pitt’s, then chances are that the country’s central bank will have to raise interest rates to control inflation. This is good for the carry trade because a higher interest rate means a bigger interest rate differential.

    When Do Carry Trades NOT Work? On the other hand, if a country’s economic prospects aren’t looking too good, then nobody will be prepared to take on the currency. Especially if the market thinks the central bank will have to lower interest rates to help their economy. Put, carry trades work best when investors have a low-risk aversion. Carry trades do not work well when risk aversion is HIGH (i.e., selling higher-yielding currencies and buying back lower-yielding currencies). When risk aversion is high, investors are less likely to take risky ventures.