Carry trade strategy

Many of you, when familiarizing yourself with currency pairs and trading tactics, have repeatedly heard such an expression as Carry trade, but there is very little sensible information about this trading tactic on the Internet.

The fact is that Carry means a fee for providing a certain service. So, for example, if you were trading in the commodity market, you would pay Carry for holding your goods in a warehouse, and in the case of shares, you pay the holder of your shares.

In the foreign exchange market, Carry is charged by the broker for holding a position for the next day, so sometimes when you look at data on open transactions in your trading terminal, you may see a negative or positive value in the Swap column.

Carry trade strategy: practical application in Forex.

In the forex market, the calculated swap is our carry; it's just that the term swap has been commonly used internationally. So where does the swap itself come from, and how is it calculated?

A swap is the difference in interest rates between the central banks of the currencies we trade. When trading forex, we don't actually buy currency with cash; in speculative trading, we borrow one currency and use it to buy another.

As you know, each country has its own interest rate at which we borrow money, so when we roll a position over to the next day, we pay a kind of debt for using borrowed funds. The difference in interest rates is what creates our carry, which can be either positive or negative. Before we dive into the strategy, let's clarify what an interest rate is.

An interest rate is the fee charged to a bank for lending money. As you understand, interest rates vary across countries. For example, Japanese yen can be borrowed at 0.1 percent, while in Europe, the central bank lends euros to its banks at 0.05 percent.

Reduced market liquidity and volatility have meant that traders are simply no longer able to profit sufficiently from exchange rate differences, leading to the emergence of a new approach to forex trading called carry trading.

The idea is that a trader receives a daily positive swap on their account for holding their position, and under favorable circumstances, also profits from the exchange rate difference. To understand the concept, imagine borrowing Japanese yen at 0.1 percent to buy Australian dollars with an interest rate of 2 percent.

Next, you keep the Australian dollar in a safe deposit box, and you receive our positive swap of 2 percent. The difference between the debt rate and the one we received is 1.9 percent, which is our profit. The same principle applies to the swap, so by buying a currency with a high interest rate for a low one, you receive a positive swap, and this is the basis of the entire carry trade.

To begin trading using the carry trade strategy, you need to select currency pairs with high and low interest rates, with a significant difference. To do this, open the latest interest rate data. Your goal is to buy the currency with the high interest rate and sell the currency with the low interest rate.

Profit for holding a position is calculated after the clock passes 24:00, and overnight from Wednesday to Thursday, the swap is calculated at a triple rate. Classic currencies with low interest rates include the Japanese yen, the euro, the Swiss franc, the British pound, as well as the currencies of Sweden and Denmark.

Some traders also include the US dollar in the above-mentioned categories, but it's not suitable for carry trades because it's a highly speculative currency, and the difference in exchange rate movements can simply offset any profit from a positive carry. Currencies with high interest rates include the Australian dollar , New Zealand dollar, Brazilian real, and South African rand.

Calculating your potential profit is quite simple: subtract the lower interest rate from the higher interest rate, then multiply by the position size, divide by 100, and divide by the number of days in a year. This way, you can determine the amount of money you'll earn per day using the carry trade strategy.

Unfortunately, trading with this strategy isn't as simple as it seems at first glance. The fact is, for this strategy to be effective, the market must be calm, without any major crises.

It's also worth choosing an instrument whose trend clearly aligns with the positive swap accrual. Otherwise, if you enter against the trend and it moves strongly against you, no profit from the carry trade strategy will save you from the exchange rate difference. Therefore, it's best to find currency pairs that are either stagnant within a narrow price range or, if you buy a currency pair with a high interest rate, its trend should also be moving upward.

When selling an asset with a low interest rate, the conditions are the same, but in reverse. It's also important to remember that you need to choose currency pairs that maintain a stable interest rate, as frequent changes in the interest rate will simply prevent you from making money due to the high exchange rate differences it causes.  

In conclusion, I would say that for successful trading using the Carry Trade strategy, it is necessary to form a basket of different currency pairs, since unexpected changes in interest rates on one currency pair can be offset by stability on another trading instrument.

Try to choose instruments with significantly different interest rates. For example, the ZAR/JPY currency pair has radically different interest rates : the South African rand is 6 percent, while the Japanese yen is only 0.1 percent. Choose your currency pairs carefully, as this will determine your future profits.