Carrying Trades in Forex : Trading For Interest

People have often think about systems which they can trade that will bring them the most long term profit with the least risk. Some of the most popular systems used to achieve this by large investors and banking institutions is the carry trade. What is this popular form of investment which is so common amongst these “big guys” ? The carry trade is simply when you buy a high yielding currency with a low yielding currency, getting an overnight interest on your position. Today’s post will be dedicated to the discussion of the carry trade and why it is in fact a good yet NOT risk free fundamental-based strategy.

So how do you place a carry trade ? As I say, you need to buy a high yielding currency with the lowest possible low yielding currency (to get the highest possible interest). For example right now you could buy AUD with USD since the interest rate of the Australian central bank is 4.00% and the US central bank’s is 0.25%, effectively giving you a very favorable interest differential. Once you get into this position you will receive an overnight interest which is often called the “swap” which is 6 USD for each 100,000 USD. In the year you would get about 2190 USD which would mean a 2.2% interest rate.

But why isn’t the carry trade risk free ? When you buy any forex pair, you effectively expose yourself to the variation of the instrument’s value. For example, if you bought AUD/USD at 0.8 and then after a year it is at 0.6, then the fact is that you lost 25% in addition to the 2.2% you made on interest so the actual exposure you have to the variation in the currency’s value is what will make or break your profits. There is also the opposite possibility that the AUD/USD goes up to 1.0 effectively making you 25% profit.

People often try to reduce their risk in carry trades by hedging different currencies, but what they are effectively doing is changing their risk from one instrument to another. For example, hypothecally, if AUD/USD and USD/EUR were carry trades, then buying both would just mean you are exposing yourself to AUD/EUR. In fact, the forex market is made in such a way that reaching a combination of pairs which give positive swap and a final exposure to X/X (AUD/AUD on our previous example) simply does NOT exist. This is due to the fact that such a combination would be a sort of arbitrage since it would give you almost no risk.

In fact, it may be reasonable to get into different positive carry trades to diversify risk somewhat but this does not mean that your trading is risk-free. In fact, when the carry trade unwinds, due to changes in central bank interest rates (like in 2008), people will lose on ALL their carry trades, no matter the different amount of pairs they actually have. If you want to trade for interest, you need to realize that what you are doing is playing a fundamental game which will change players as the economy changes. The carry trade is NOT a set and forget strategy, you need to stay on top of the interest rates and close your positions as the gap between interest rates becomes lower.

You also need to take into account your exposure to changes in the currency pairs. Always trade such that you will not buy more lots than what you have in your account. With 1:100 leverage this means that you need to reduce the trading size by a factor of 100. For example, if you have a 1000 USD account, instead of trading 1 lot which equals 100,000 USD, trade 0.01 lots which equals 1000 USD. This way you will be absolutely covered and you will only get wiped out if the currency pair you get reaches 0. However you can increase your risk a little bit more to 0.02 meaning that you would only get wiped out by a 50% variation of the currency, something which is also very unlikely.

The best moment to start investing in a carry trade is as soon as the swap becomes positive. When this happens people start to put money into the carry trade and you are in for a long term ride, however always consider the above risk statements and have your account ready for draw downs which WILL happen when you take a carry trade. Also remember to exit positions when there are signs of economic turmoil, which may happen every 6-10 years. It is of the utmost importance to always have in mind that the carry trade is a fundamental strategy and as such it demands constant vigilance over economic conditions and interest rate differentials.

If however you are not interest in the carry trade but you would like to know more about my automated trading systems and how you too can learn to program your own long term profitable trading systems please consider buying my ebook on automated trading or joining Asirikuy to receive all ebook purchase benefits, weekly updates, check the live accounts I am running with several expert advisors and get in the road towards long term success in the forex market using automated trading systems. I hope you enjoyed the article !

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