Carry Trade
Forex
Below is a chart illustrating a typical example where the carry-trade strategy could be applied. The chart shows a steady increase of the GBP/JPY pair in 2005 and 2006, spawned, among other things, by carry traders going long to obtain the interest-rate differential.
- Buy 204.73
- Sell 221.25
-
Profit from Position =$13,909.84 Profit from Interest = $8,157.75 Total Carry Trade Profits =$22,067.59
| Profit Potential: | GBP/JPY | Interest | |||
|---|---|---|---|---|---|
| 1 Standard Lot GBP/JPY | Bought | 204.73 | GBP Return | 4.50% - 5.00% | |
| Sold | 221.25 | JPY Costs | 0.00% - 0.25% | ||
| Profit in U.S. Dollars | $13,909.84 | Approx. Daily Return | $22.35 | ||
| Profit From Interest | $8,157.75 | ||||
| Total Profits | $22067.59 | ||||
Setting Up The Carry Trade
Understanding the role that interest rates play in the forex market is a crucial task in becoming a successful carry trader. A country offering high interest rates will attract more capital as investors seek to capitalize higher returns. As interest rates rise, investments will follow, which can in turn increase the value of the currency. A carry trader's focus then becomes the expectation on the direction of a country's interest rate, to ensure their high rate of return.
| Current Central Bank Rates * | |
|---|---|
| NZD 2.50% | AUD 4.00% |
| GBP 0.50% | USD 0.25% |
| CAD 0.25% | EUR 1.00% |
| CHF 0.25% | JPY 0.10% |
* As of April 2010
TIP:
Traders generally seek to buy currencies with high interest rates and seek to short currencies offering low interest rates.
Placing a Carry Trade
The carry trade works best under certain market conditions, and the selection of the currency pair can make the difference between a losing trade and a profitable one. When selecting a currency pair, traders want to observe two things. First, the trader wants to make sure they are buying the currency that has the higher interest rate and selling the currency that has, in comparison, a lower interest rate.
Second, the trader also wants to view the health of the economy for the currency pair to ensure the market will move in their favour. Essentially, the trader will be buying a currency with a stronger economy and selling the currency with a weaker economy. Some currency pairs that are usually selected to apply the carry trade strategy are the GBP/JPY, GBP/CHF, AUD/JPY, EUR/JPY, CAD/JPY, and USD/JPY.