Carry trade involves going long on a higher-yielding currency while shorting a lower-yielding one. In other words, to benefit from positive carry, you have to buy a currency with a higher interest rate against a currency with a lower interest rate. The interest rate differential will allow you to make profits if you hold on to the trade for at least a day even if price doesn't move at all.
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.
Remember also that risk sentiment must be on your side when taking advantage of carry trades. This means that market sentiment should be favoring a rally of higher-yielding currencies versus lower-yielding ones, as traders would rather take on more risk. This way, you can have positive returns from your forex trade and add to your wins with the positive interest rate differential. On the other hand, when risk is off and higher-yielding currencies are selling off, you can still earn from positive carry but lose on your forex trade.
The bottom line is that you have to remember two things when trying to benefit from carry trade. Firstly, you have to buy a higher-yielding currency or one that has a higher interest rate and sell a lower-yielding currency or one that has a lower interest rate. Secondly, you need to make sure that risk appetite is up so that you can also earn from a winning forex trade on top of a positive interest rate differential.
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.
Remember also that risk sentiment must be on your side when taking advantage of carry trades. This means that market sentiment should be favoring a rally of higher-yielding currencies versus lower-yielding ones, as traders would rather take on more risk. This way, you can have positive returns from your forex trade and add to your wins with the positive interest rate differential. On the other hand, when risk is off and higher-yielding currencies are selling off, you can still earn from positive carry but lose on your forex trade.
The bottom line is that you have to remember two things when trying to benefit from carry trade. Firstly, you have to buy a higher-yielding currency or one that has a higher interest rate and sell a lower-yielding currency or one that has a lower interest rate. Secondly, you need to make sure that risk appetite is up so that you can also earn from a winning forex trade on top of a positive interest rate differential.
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