Carry trade involves going long on a higher-yielding currency while shorting a lower-yielding one. In other words, to benefit from positive carry, you have to buy a currency with a higher interest rate against a currency with a lower interest rate. The interest rate differential will allow you to make profits if you hold on to the trade for at least a day even if price doesn't move at all.
For instance, if you buy Australian dollars and sell the euro, you get a carry trade of 2%. This is because the Reserve Bank of Australia offers 2.50% interest while the European Central bank currently has 0.50% interest. The leverage and account size in forex trading, along with the length of time you hold on to a trade, can compound this interest rate.
When you keep a trade open for a day, what really happens is that your broker closes the position at the end of the day then reopens it the very next day. It happens automatically so you won't see this on your platform. In turn though, the interest for the next day is rolled over and gets added or subtracted from your account.
Carry trade can work against you too if you are short a position on a higher-yielding currency versus a lower-yielding one. For example, if you are selling New Zealand dollars in exchange for U.S. dollars and you held on for a day, you get a -1.50% return since the RBNZ gives a rate of 2.00% while the Fed has 0.50%.
Carry trades tend to work best when risk appetite is on and traders are buying up higher-yielding currencies. This means that you get to earn from the trade itself as you are also long on the higher-yielding currency plus you also earn from the positive carry. On the other hand, when risk is off and traders are short higher-yielding currencies, you still have a chance to earn from positive carry but the gains will be offset by your losing forex trade.
At the end of the day, there are two things you need to remember when trying to take advantage of carry trade. One is that you need to look for a currency that offers higher returns and buy it against another currency that offers lower returns. Two is that you have to make sure that risk taking is on so that you reap benefits from your winning forex position along with the positive carry.
For instance, if you buy Australian dollars and sell the euro, you get a carry trade of 2%. This is because the Reserve Bank of Australia offers 2.50% interest while the European Central bank currently has 0.50% interest. The leverage and account size in forex trading, along with the length of time you hold on to a trade, can compound this interest rate.
When you keep a trade open for a day, what really happens is that your broker closes the position at the end of the day then reopens it the very next day. It happens automatically so you won't see this on your platform. In turn though, the interest for the next day is rolled over and gets added or subtracted from your account.
Carry trade can work against you too if you are short a position on a higher-yielding currency versus a lower-yielding one. For example, if you are selling New Zealand dollars in exchange for U.S. dollars and you held on for a day, you get a -1.50% return since the RBNZ gives a rate of 2.00% while the Fed has 0.50%.
Carry trades tend to work best when risk appetite is on and traders are buying up higher-yielding currencies. This means that you get to earn from the trade itself as you are also long on the higher-yielding currency plus you also earn from the positive carry. On the other hand, when risk is off and traders are short higher-yielding currencies, you still have a chance to earn from positive carry but the gains will be offset by your losing forex trade.
At the end of the day, there are two things you need to remember when trying to take advantage of carry trade. One is that you need to look for a currency that offers higher returns and buy it against another currency that offers lower returns. Two is that you have to make sure that risk taking is on so that you reap benefits from your winning forex position along with the positive carry.
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