Forex carry trade strategy

Forex carry trade strategy

October 29, 2020 by Martin Sukhor
Forex carry trade strategy is one of the trading methods by forex traders with the aim of getting profit. Carry Trade is a way of trading looks special attention from differences in interest rates on certain pair. When opening an open position for a long time. This is because differences in interest rates are made
Forex carry trade strategy

Forex carry trade strategy is one of the trading methods by forex traders with the aim of getting profit. Carry Trade is a way of trading looks special attention from differences in interest rates on certain pair. When opening an open position for a long time. This is because differences in interest rates are made when foreign exchange positions are opened overnight.

When a trader buys a currency that has a higher interest rate compared to the opponent’s currency, you can take advantage of a positive carry. Simply, you get a little interest in your forex position. If you let the order open until the next trading day and your broker will add that amount to your profit.

In other words carry trade strategy is carried out by borrowing money in a low-interest rate country, then spending it in a high-interest rate country.

A simple example, an investor borrowing 1,000 yen from a bank in Japan that has a low-interest rate. Then the 1000 yen is spent or exchanged into US dollars. With the dollar to buy bonds in an equivalent amount.

In this way, investors assume that the bonds will provide a higher yield than the cost of interest in Japan.

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Carry trade strategy explained

The carry trade method is also applied in forex trading. Understanding the Carry Trade forex is a way of trading by prioritizing profits from the difference in interest rates between currency pairs traded.

So it’s not profiting from changes in exchange rates between the currencies themselves. Carry Trader, will take action to Buy currencies with higher interest rates. And at the same time Sell currency with lower interest rates.

So to apply the carry trade strategy. The trader must know the value of the interest rate on the currency pair traded. So that he will understand exactly what currency will Buy and which pair will Sell.

In Carry trade, there is a positive carry term. This refers to traders who buy currencies that have a higher interest rate compared to the opponent’s currency. By holding the position for days the trader utilizes the positive carry and the broker will give a positive swap into the trading account.

Conversely, negative carry is referring to traders who buy currencies at lower interest rates and sell to currencies at higher interest rates. When you leave a position open for a few days. The broker will take a certain amount of your money in a trading account to adjust the interest rate calculation for both currencies.

List of currency pairs with a positive swap

Because carry trade is to take advantage of differences in interest rates to get a profit, on the difference between bank interest rates. Then the currency pair chosen for this strategy must meet two requirements:

  • Having positive swaps
  • Opening an order in the right direction refers to a trend that has the same direction as trade opened with a carry trade strategy.

If both conditions are not fulfilled, the carry trade strategy can also cause losses in forex trading. For example, if you open a Buy USDCHF position and get a positive swap, but if the trend pair direction tends to be bearish then you will experience a floating minus even if you get a positive swap whose amount is not much compared to your floating loss,

And it is important to read the swap calculation on your broker. because different brokers sometimes have different swap calculations, some give high yields and some are lower.

Here of the list currency pair with a positive swap

  • USDCHF Long 0.33% 1.01%.
  • NZDCHF Long 0.18% 1.40%.
  • AUDCHF Long 0.16% 1.15%.
  • EURUSD Short 0.06% 0.91%.
  • GBPCHF Long -0.01% 1.06%.
  • CADCHF Long -0.06% 1.25%.
  • EURNZD Short -0.09% 1.03%.
  • EURCAD Short -0.11% 1.01%.
  • EURGBP Short -0.16% 0.93%.
  • USDJPY Long -0.18% 1.03%.
  • EURAUD Short -0.21% 0.94%.
  • CADJPY Long -0.27% 1.11%.
  • NZDJPY Long -0.35% 1.32%.
  • CHFJPY Short -0.38% 0.96%.
  • GBPUSD Short -0.46% 0.96%.
  • GBPJPY Long -0.46% 0.97%.
  • AUDJPY Long -0.51% 1.18%.
  • EURCHF Long -0.62% 0.92%.
  • AUDUSD Short -0.62% 0.99%.
  • GBPNZD Short -0.64% 0.93%.
  • USDCAD Long -0.66% 0.90%.
  • EURJPY Short -0.67% 0.93%.
  • GBPCAD Short -0.75% 0.97%.
  • AUDNZD Short -0.81% 1.08%.
  • GBPAUD Short -0.87% 0.92%.
  • CHFSGD Short -0.92% 1.93%.
  • NZDCAD Long -0.95% 1.06%.
  • AUDCAD Short -0.99% 1.15%.
  • EURSGD Short -1.02% 2.17%.
  • SGDJPY Long -1.04% 1.92%.
  • NZDUSD Short -1.10% 1.11%.
  • USDHKD Short -1.18% 1.50%.
  • USDSGD Long -1.53% 1.70%.
  • EURHKD Short -1.68% 2.73%.
  • AUDSGD Short -1.86% 2.27%.
  • GBPSGD Short -1.89% 2.41%.
  • NZDSGD Short -3.23% 3.34%.

The pair list was updated in June 2020, so when you start to have a pair for this carry trade strategy, you must also update the interest rate changes on the traded pair. But it is very rare cases of changes in interest rates in large percentages, usually only a few basis points.

How to carry trade?

A Carry-Trader will buy the currency with the highest interest rate and sells the currency with the lowest interest rate. This will get the maximum profit.

For example, if the current Australian dollar interest rate is 3.25% per year and the Japanese Yen is 0.1% per year, then buy AUD/JPY, a Carry-Trader will get benefit from:

  • Buy AUD, the trader earns 3.25% interest.
  • At the same time selling JPY, traders pay 0.1% interest.

If the exchange rate of AUD against JPY remains the same or is relatively immovable too significant. Then in a year, a Carry-Trader will get a profit of 3.15% of the difference between the two currencies. If the trader trades with a standard (regular) lot or AUD 100,000 contract size, then he will earn a 3.15% interest per year.

If trading with a leverage of 200: 1, then with a margin of AUD 500 will get AUD 3,150 from the difference in interest rates.

Does carry trade work?

Yes, carry trade can work very well as long as the currency remains stable. And your position is in the direction of the trend. Traders can count on stable returns from high-yield currencies.

This strategy can work better when the currency in a high-interest rate country. When an investor sells a bond, he can pay off loans in low-interest currencies with a stronger currency. Hence Investors get profits.

If many investors do the same thing, it can increase the demand for high-interest bonds. By selling bonds in the secondary market, investors can profit.

If the demand for high-interest bonds increases, it can be a factor in the increased demand for currencies. Currency values ​​will increase and create further benefits for high-yield bondholders.

How to calculate carry trade returns

To calculate the profit from Carry trades, we must remember the main principle in calculating swap on forex is: You pay interest on the currency sold and in return earn interest on the currency purchased. Because forex trading always deals with one currency pair, calculating the difference in swap value is inevitable.

In this case, note that when you open a buy order on a pair (for example AUD/USD), it means that you are buying the first currency (AUD) and selling the second currency (USD). The same rule applies to sell orders, which means that you are going to sell AUD and at the same time buy USD.

An example of a simple calculation is that you are trading the AUDUSD pair with the Australian central bank’s interest rate of 2%, while the Fed’s benchmark interest is set at the 1.5% level.

If you open a long AUD/USD position and hold it past midnight on broker server time, your swap calculation will be 2% – 0.5% = 1.5%.

Because it is positive, you will not be charged a cost, but instead, get an interest of 1.5%. On the other hand, if you open a sell AUD/USD order and let it stay overnight, the swap calculation will be 1.5% – 2% = -1.5%. In other words, you will be charged a swap fee of -1.5% per lot, which is automatically deducted from your trade gain.

You can imagine if you carry out a carry trade by holding the transaction for a year it can give a high gain. However, it does not mean that it is without risk, for example, a currency devaluation occurs with high changes in interest rates, which consequently applies to the results.

Why might a carry trade end​ badly?

Carry trades are not always profitable, several conditions may affect the final result of closing carry trade positions, the following are among the causes of bad results in a carry trade strategy:

  • High price volatility. Volatility is a major factor in carry trade should pay attention to. If there is a high volume change in financial markets, then volatility will increase. If the change in the Average Daily Range is greater, the volatility is also higher, a position that does not match the change in volatility can cause bad results on the carry trade.
  • Lower Interest Rate. If the global economic situation is at high risk and has a negative impact on the market, several central banks will carry out a policy of cutting interest rates. This will have an impact on the initial calculation of the carry trade plan in the long term, when there is a decrease in interest rates, traders must evaluate to adjust to the current condition.
  • Government Intervention. The government can intervene in the forex market if the currency exchange rate is considered too strong or too weak according to the reference expected by the central bank. With intervention, the value of the currency will rapidly strengthen or weaken. This of course has an effect on the volatility and exchange rate of the Carry Trade currency pair, if the trader’s position goes against the direction of the price trend, causing bad results on the carry trade.

Bottom line

The carry trade strategy can provide profit even if the price does not move at all, and above all is a long-term plan, where traders must be in accordance with the position against the market trend.

Carry trades can provide additional profit if the trading position matches the direction of the long-term trend. However, if the position is against the trend, carry trades do not help much in minimizing losses due to price fluctuations that are not in line with the trading position.

Therefore carry trade traders must understand positive and negative carry trade positions, as well as the direction of the main trend, this will maximize profits in carry trades.

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