Carry trade refers to a strategy where a trader sells currency with low interest rate and at the same time buys a different currency with higher interest rate. The idea behind it is to seize the difference between the rates and make profits, based on the leverage used.
What is Carry Trade Strategy?
First you have to figure out the interest rate differential and the forecast for the selected currency pair. Then you basically go long a currency with a high interest rate and short a currency with a low interest rate. Hold the position for a while based on your trading plan to take advantage of the interest rate differential.
The trick is to find a currency pair that will have an exchange rate movement during the carry trade which favors the higher interest rate currency.
Widely held carry trade currency pairs are:
The Risks Involved in Carry Trade
Nothing is for free and, like everything in trading, carry trade may results in substantial loss. What can possibly go wrong? Let’s see…
1. Higher the Leverage = Bigger the Disaster!
High leverage used in carry trade can result in losses if the market moves sharply in the undesirable direction. Your trade is then prone to hit the margin calls or to be automatically closed when the stop/loss is reached.
2. Interest Rate can Shift
In case the interest rate differential broadens – good for you! This is exactly what you are looking for.
On the other hand, if the interest rate differential shrinks down, you will end up with almost no return.
Forex carry trading risks are there, however it is simply impossible to ignore the potential profits and chunks of serious cash made in the process! After all, there is no way of making real money without even a slightest pinch of risk involved, don’t you agree?!