Know Carry Trading
In currency markets, carry trading is done by many investors to take benefit of the basic economic principle that money flows where the returns are high. This constant flowing in and out of capital between the different markets is what makes carry trading profitable.
Carry trading is quite popular among professional forex traders. Hedge funds and investment banks also do leveraged carry trading to make profits. You as a retail forex trader can also benefit from carry trading.
What is a carry trade? In nutshell, carry trading means taking advantage of interest rate difference between two currencies in a currency pair. Investors take benefit of the interest rate differential between two currencies by going long/buying the high interest rate currency and going short/selling the low interest rate currency.
Lets use a simple example to make it clearer: lets assume, New Zealand dollar is offering an interest rate of 4.75% whereas the Japanese yen is offering an interest rate of 0.25%.
An investor will want to benefit from this interest rate differential. He/she will buy New Zealand dollars (NZD) and sells Japanese Yens (JPY). He/she can earn a profit of 4.75-0.25=4.5% so long NZD/JPY exchange rate does not change. If the investor can handle leverage and uses a leverage of 20:1, this 4.5% return will be magnified into 90%.
Another thing that can go in favor of the investor is if the currency pair NZD/JPY appreciates, he/she can get capital appreciation as well as a yield. Many times, appreciation will also happen as many other investors also jump on the bandwagon when they see a good carry trading opportunity.
However, carry trading depends a lot on the mood of the investors as a group. When investors have low risk aversion, carry trades will be profitable. But suppose the investors as a group suddenly develop high risk aversion and run to take refuge in safe haven currencies. In this scenario, carry trading will become unprofitable.
By entering into a carry trade, an investor expects to profit from an interest rate differential between the two currencies. But if the low interest rate currency appreciates considerably for some reason or another, carry trade will become unprofitable.
How do you check the mood of the investors? By knowing whether the currency is overbought or oversold. For this you need to identify the current trend of the currency pair and see whether it is moving in the right direction!
You can use the MACD (moving average convergence divergence) indicator to identify the trend. - 23217
Carry trading is quite popular among professional forex traders. Hedge funds and investment banks also do leveraged carry trading to make profits. You as a retail forex trader can also benefit from carry trading.
What is a carry trade? In nutshell, carry trading means taking advantage of interest rate difference between two currencies in a currency pair. Investors take benefit of the interest rate differential between two currencies by going long/buying the high interest rate currency and going short/selling the low interest rate currency.
Lets use a simple example to make it clearer: lets assume, New Zealand dollar is offering an interest rate of 4.75% whereas the Japanese yen is offering an interest rate of 0.25%.
An investor will want to benefit from this interest rate differential. He/she will buy New Zealand dollars (NZD) and sells Japanese Yens (JPY). He/she can earn a profit of 4.75-0.25=4.5% so long NZD/JPY exchange rate does not change. If the investor can handle leverage and uses a leverage of 20:1, this 4.5% return will be magnified into 90%.
Another thing that can go in favor of the investor is if the currency pair NZD/JPY appreciates, he/she can get capital appreciation as well as a yield. Many times, appreciation will also happen as many other investors also jump on the bandwagon when they see a good carry trading opportunity.
However, carry trading depends a lot on the mood of the investors as a group. When investors have low risk aversion, carry trades will be profitable. But suppose the investors as a group suddenly develop high risk aversion and run to take refuge in safe haven currencies. In this scenario, carry trading will become unprofitable.
By entering into a carry trade, an investor expects to profit from an interest rate differential between the two currencies. But if the low interest rate currency appreciates considerably for some reason or another, carry trade will become unprofitable.
How do you check the mood of the investors? By knowing whether the currency is overbought or oversold. For this you need to identify the current trend of the currency pair and see whether it is moving in the right direction!
You can use the MACD (moving average convergence divergence) indicator to identify the trend. - 23217
About the Author:
Mr. Ahmad Hassam has done Masters from Harvard University. He is interested in day trading; stocks and forex. Read about Trend Forex System. Best Forex Signal Service. Learn Forex Trading.
posted by X - Men @ 4:56 AM
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