Carry Trade

Carry Trade is perhaps the oldest and most commonly used trading strategy that is quite simple and hence quite popular. Similar to many other strategies, this one is based on the principle buy low, sell high. 

Simply put, it is borrowing one currency with lower yield in order to buy another one with higher yield. The important thing here is that the difference between the interest rates of those currencies should be significant. In fact, it is very convenient to use the Carry Trade strategy on Forex, because there are always two currencies in a pair, so any deal usually involves two currencies. For example, when you buy the EUR/USD pair, you actually buy the euro and sell the dollars. 

As of August 2020, the interest rate of the US Federal Reserve Bank was 0.25%, whereas the ECB interest rate was at 0%. Therefore, to profit from the difference in those rates, a trader would borrow the euros to exchange them for the US dollars. In such a case, he or she would pay the lending fee of 0% but receive the annual interest rate of 0.25%. If the leverage of 1:10 were used, that would make the profits 10 times higher. That is, if the difference in rates remained the same, the trader would gain 2.5% profits. But in such a case, the risk would also have been 10 times higher. Conversely, if the trader sold the dollars and bought the euros, he or she would have been charged the difference in exchange rate of 0.25%. 

Technically, all positions on Forex are closed at the end of each trading day despite the fact that the market works 24/5. Therefore, all forex brokers close and reopen the deals that remain open by the end of the day. This procedure is called a rollover, i.e. the position is “carried” to the next day. The fee that is accrued or deducted for the rollover is a swap. Traders who don’t want to pay or receive such commissions can enable the swap-free option which is available with InstaForex for free. 

Since this strategy is directly connected with the interest rates of the central banks, traders need to be aware of all scheduled monetary policy meetings where the rate decisions are usually taken. Any signs of a possible hike or reduction in the interest rate can help traders determine when the Carry Trade strategy will be beneficial.  

Uncertainty about exchange rates poses a great risk in Carry Trade. The exposure increases when a trader uses a leverage. Even a slight change in exchange rates can cause significant losses.