Carry Trade – Alternative Forex Trading Strategy
Carry trade is a Forex trading strategy that is very different from other Forex trading strategies in the way that it operates. All of the Forex trading strategies that we normally use are based on the concept of buy low/sell high as the basis to all Forex trading. These strategies rely on the fluctuation of the market and are useless in a stable market which does not trend in any direction. Carry trade is a strategy that allows us to make a profit even when the market is very stable as it does not rely on the movement of the price between two currencies but rather on the difference between the interest rates of two currencies.
So how does it work?
The way to use carry trade is to buy a currency that has a high differential ratio, meaning that the interest rate of the currency that you are buying is higher than that of the currency you are selling. The profit that you make will derive from the differences between interest rates, and the higher the differential, the greater your profits will be. When choosing which currencies to trade, we must take into consideration the expected changes in interest rates of both currencies. Carry trade works best when the interest rate of the currency we are buying is expected to go up and the interest rate of the currency we are selling is expected to go down. That way we stand to profit the most from the trade.
When using carry trade we make our profit from the differences in interest rates between two currencies, but that doesn’t mean that the changes in price between the two currencies are irrelevant. If for example, we chose to invest in a currency because of a high interest rate but the price of that currency dropped, then when we close that trade we might find that even though we profited from the interest rate we lost money from the trade because of the difference in buy/sell price. For that reason, carry trade is only fit for a sideways moving market and we must anticipate the movement of the price and only trade if the price is expected to remain more or less the same. Of course, the most profitable way to use carry trade is to combine it with other Forex trading strategies and enter a trade where we stand to profit both from the price movement and from the differences in interest rates, but opportunities like these are rare and hard to find.
Which currency pairs are right for carry trade?
AUD/USA, NZD/USA, AUD/JPY and EUR/JPY are the most popular currency pairs when using this method as they represent very stable economies which lead to low risk currencies. High differential ratios are the first thing to look when searching for a fitting currency pair. Remember, the differential ratio of a pair when buying is always the opposite of the differential of a pair when selling, so don’t get confused and enter a trade only if it has a positive differential ratio. If the differential ratio is also expected to grow, meaning that the interest rate of the stronger currency is expected to increase and that of the weaker currency is expected to decrease, then mark that currency pair as a potential trade. Before making the trade, make sure that the currency pair has been stable for a long time, ideally with a slight upward trend in order to avoid any surprises.