Carry Trade Strategy – an overview:
When it comes to currency trading, the carry trade strategy is one of the most popular strategies. In addition to retailers, this is also used by hedge funds. The system is to buy a high-interest-rate currency while selling a low-interest-rate currency. As a result, traders can benefit not only from price fluctuations, but also from interest earned on holding overnight. Of course, this only works if the chosen broker also pays interest for holding a position. The carry trade strategy should only be applied under normal conditions and not during a crisis or a longer-term correction.
Advantages of the carry trade strategy:
- Gains due to price fluctuations and interest rates
- Long-term profit potential
Disadvantages of the carry trade strategy:
- Only promising for a growing economy
Application of the carry trade strategy:
- First, a currency pair is selected with a comparatively high interest rate. Suitable examples are AUD / JPY, NZD / JPY and GBP / JPY.
- Then go in the currency pair Long or Short. The direction depends on whether a positive interest rate is granted for holding.
- In order to avoid a major loss, at least on paper, the most moderate position size should be chosen.
- The carry trade strategy is one of the few strategies for which no stop loss should be set.
- Now wait until the position reaches a sufficient profit or a crisis or correction is expected.
An example: This is how the carry trade strategy can affect
Between the end of 2000 and mid-2006, the British pound had an interest rate of 5 percent. Over the same period, the Chinese yen’s interest rate was close to 0. This resulted in an overnight interest rate of nearly 5 percent. With a leverage of 1: 100, this results in an interest rate of around 2,500 per cent for the entire period. In addition, there is an increase of 6500 pips in the same period for the GBP / JPY currency pair. From this point of view, the carry trade strategy would have enabled huge profits over this period.
Not to forget that the carry trade strategy involves some risk . In 2007, the uptrend ended abruptly, leaving little time to close the relevant positions. Traders should always be aware of the risk and think carefully about whether to use the carry trade strategy.