What is a Currency Carry Trade
Currency Carry Trade, if we have previously discussed what a carry trade is, in this lesson. We will learn about how we can benefit from the difference in interest rates between currency pairs. And for sure you can apply it when running a forex trading business easily.
And we need to know that we have previously discussed that this carry trade strategy is a strategy carried out by hedge funds or financial managers in financial markets. And for more details about this, please follow the explanation below.
In the forex market, we already know that money transacted in pairs such as when you buy USD / CHF means you are buying US dollars and selling Swiss francs at the same time.
The thing that happens when you make the transaction above is that you have to pay interest rates on the currency that you are selling and you will get an interest rate in the currency you are buying.
The thing that makes the carry trade so special in forex trading is the payment of interest rates to you in every trade you make. Technically all of your trading positions will be closed at the end of the day but you will never see them the next day.
Your broker will close and open your trading position every day and then they calculate the interest rate difference between the currency pair for the transaction that you did last night. And then the amount of interest that has been calculated will be given or charged to you.
The calculated interest is called rolling over or carrying.
The leverage provided by brokers in the forex market makes this carry trade very popular among forex traders. Keep in mind that the basis of forex trading is the margin which means you only need very little capital to open a trading position because most of the shortcomings will be lent by your broker.
Many brokers make it easy for you that you only need to pay 1% or 2% of the total transaction.
Let me be clearer about the carry trade, let’s see how George is likely to get profits and losses when trading forex.
On this day George was given a gift by the boss for $ 10,000 because of his good performance. Because today he doesn’t want to use his money so he wants to save his money in the bank in the form of a 5% interest rate deposit and in his heart thinks that with $ 10,000 means that at the end of the year it will be $ 10,500 because of the addition of $ 500 from the yield by 5%.
Because George has also studied forex and is a trader who has the experience, he remembers that with the name carry trade he opened an account and began to look for which currency pairs could provide large returns.
He also chose a currency pair that offered a difference in interest rates of + 5% as well. Although the yields are the same as deposits, there are several things that deposits cannot offer, namely leverage and margins.
Then he entered all the money and opened a transaction position of $ 100,000. because the broker only needs 1% of capital from George then George only needs to have a margin of $ 1000 (100: 1 leverage). So George now controls the transaction for $ 100,000 with a yield of + 5%.
Here are some possibilities for George’s capital
- George suffered a loss, the currency pair purchased by George experienced a very deep decline. Until it touched the margin position and George experienced a margin call. So that the remaining capital is equal to the margin of $ 1000
- The price of a currency pair does not change until the end of the year. In this case, George did not experience profit. Or loss but he will only get 5% in return from the $ 100,000 transaction value of $ 5000.
- The price of a currency pair has experienced a very significant increase so that in addition to getting a 5% interest rate of $ 5000. George also gets an additional increase in the price of the currency pair.
Because of the 100: 1 leverage, George has the opportunity to get returns on interest rates of 50% of the $ 10,000 capital.
The following is an example of a currency pair that can provide a difference in interest rates of 4.4% in September 2010.
If you open a BUY (LONG) AUD / JPY position then you will benefit from the interest rate of + 4.4% but if you open an opposite position that is SELL (SHORT) AUD / JPY then you will be charged interest of -4.4%.
Well, that was what was written about the currency carry trade that can provide returns on the difference in interest rates. But do not get the wrong position because if the wrong position is the opposite, you will be charged interest.