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Forex Trading

Forex Trading Strategy, The Carry Trade

Forex Trading Strategy: The Carry Trade

Individual forex traders who invest online often discard the carry trade forex trading strategy, thinking that it's only a worthwhile strategy for large institutional investors such as hedge funds, which typically have more money at their disposal than the average online forex trader.

While it is true that the bigger your position, the more you can benefit from utilizing the carry trade forex strategy, online individual forex traders should by no means dismiss the carry trade as a concept that has nothing to do with them.

Investors of all sizes should keep currency trading strategies such as the carry trade in mind as a viable option. It is always gratifying to receive money for doing nothing, and that's what the carry trade is all about.

Rollover Rates: Sometimes They Pay You, Sometimes You Pay Them
When you or forex broker buys a currency pair, you are buying one currency and selling another. Conversely, when you sell a currency pair, you are selling one currency and buying another.

Each currency has a certain interest rate associated with it, as dictated by the central banking authority of that country. When one currency in your chosen pair has a higher interest rate than the other currency in the pair, you have an interest rate differential.
Each period of time that you hold that currency pair, you will be paid interest if you are on the long side of the currency that has the higher interest rate. Or, if you are long the currency with the lower interest rate, you will have to pay interest to your forex broker.
Many times the rollover rate is not that significant either way, but it is still money and as such should be considered when you are placing trades involving low or high interest rate currencies.

At the very least, you should know the interest rate differential of every currency pair you trade. Not knowing that you're holding a position with a large interest rate differential can cost you real money on a daily basis. This cost will be noted as "Rollover" on your forex broker account.

Textbook Example: The Yen Carry Trade
Perhaps the best way to go a bit deeper into the carry trade concept is to note the foremost practitioner of the phenomenon: Japan. Over the years, Japan has consistently kept interest rates low, which has in turn kept the value of the Japanese Yen at a low level.

The reason Japanese economic leaders would desire a weaker Yen is simply so that Japanese exports would be cheaper when they are sold to foreign markets such as the U.S. and Europe. If $1 U.S. Dollar is worth 128 Yen, Japanese products can be priced attractively to Americans.

The upshot for forex traders of this policy has been that you can get paid the difference in interest rate between the Yen and whatever other currency you pair it against. In essence, you would be paid a premium for borrowing--or "carrying"--the Yen.
If 3 percent doesn't sound like a lot, don't forget that it would be 3 percent on the leveraged amount of your position, not just the margin you put down to obtain that position. For example, a position of $200,000 at 3 percent interest can be a nice little dividend.

Imagine the rollover interest rate paid on a $3 billion position and now you're starting to understand the power of the carry trade forex strategy as far as big players are concerned.

What the Carry Trade Means to the Individual FX Investor
Individual online forex traders may not hold big enough positions for the carry trade to make or break a trading account, but as noted, every little bit helps if it is paid to you and every little bit hurts if you have to pay it out. Not paying rollover rates is a smart way to keep costs down.

Taking a grander view, thinking about what the big players are thinking about is always a good idea. You can guarantee that the carry trade is a perpetual consideration for these big players, so the fact that you're familiar with the carry trade strategy is indication that you're a smart trader.

Important Forex Information

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While it is true that the bigger your position, the more you can benefit from utilizing the carry trade forex strategy, smaller investors can beneit, too. Read about the carry trade.  arrow