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Carry Trade Strategy

Carry Trade Strategy

KEY TAKEAWAYS

  • Carry trade strategy is very popular.
  • Since carry trading is a high risk strategy, we welcome investors with a high tolerance for losses.
  • When to get in a Carry Trade and when to get out.

What is Carry Trade

A Carry Trade is a trading strategy, which is borrowing at a low interest rate and investing in an asset with a higher interest rate. In other words a carry trade is most of the time based on borrowing in a currency with a low interest rate and converting the borrowed amount into another currency. And, of course, this method can be used on stocks, commodities, real estate and bonds that are denominated in the second currency.

And as any trading strategy, Carry Trade strategy also has pros and cons:

Cons

  • There is a risk of sharp decline in currencies exchange rate, which will probably kill the profit.
  • Same with invested assets - they can change in price and drop the value of the income.
  • Hedging is an option but not very advantageous, since money spent on insuring losses will cover the profit traders earned from difference in interest rates.
  • This trading strategy can create a financial bubble.

Pros

  • One of the most attractive sides of Carry trading strategy is its simplicity.
  • Carry trading also lets trader use leverage, which sweetens the deal even more.
  • Profitability.

Overall if a trader decides to use this strategy, it’s imperative to have the skill and be on alert if any changes are to happen.

Risk Management in Carry Trading

There is no doubt that Forex trading strategy is quite juicy but carries a fair amount of risk, to polish this strategy it's advised to use risk management. Without risk management, trader’s account can be wiped out by an unexpected turn. The best time to enter carry trades is when fundamentals and market sentiment support them. Don’t forget the proper hedging.


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So when to get in a Carry Trade and when to get out?

The best time to use Carry Trading strategy is when banks are thinking, or rising interest rates - many people are starting to buy currency, hence pushing up the value of currency pair. As long as the currency's value doesn't fall traders will manage to profit.

The worst time to use Carry Trading strategy is during the period of interest rates reduction. Change in monetary policy also means a change in currency values - when rates are dropping, demand for the currency also tends to drop as well.

Conclusion

In order for the Carry Trade strategy to result in a profit, there needs to be some degree of interest rate rising or no movement.

Carry Trade Example

Suppose the investor borrows 1000 japanese Yen with 0 interest, then converts Yen in Us Dollar, and uses the sum to buy US bonds with 5,3% interest. Investor will make a profit of 5,3%, as long as the exchange rate between US dollar and Yen stays the same.

Many investors make currency carry trades, because it's simple and profitable especially when leverage is used. See more about what is leverage in Forex. For example if the trade mentioned above had a leverage of 10:1, trader would make 53% profit. But of course, the bigger potential gain the bigger is the risk, if exchange rate between US dollar and Yen change - f.e. If The US dollar falls in relation to Yen, trade will lose value. So when leverage is involved and the exchange rate changes, trader will lose ten times more value (if the trader doesn't hedge appropriately).

Bottom Line on Carry Trade Strategy

Bottom Line is that Carry Trading strategy is profitable, especially when leverage is used, quite simple and risky. To beat that trader has to implement proper risk management. Trader has to know when to get in a Carry Trade and when to get out. And the most important part, before using this type of risky strategy you have to have the skill and the experience.