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What is carry trade in Forex

Did you know that the carry trade is among the oldest forms of trading strategies first developed by elite money managers? As the trade involves purchasing and selling 2 different currencies only those who had access to world markets could engage. 

Carry trade definition

In the easiest terms, the carry trade is where a trader takes one financial tool to purchase another financial tool.

Carry trade example

Imagine a scenario where you take £5,000 from the bank that charges you a lending fee of 1%. Now let’s say you take that £5,000 and buy a bond that pays you 4% a year. Your profit is 3%. You have made a profit from the contrast in the interest rate.

What is carry trade in forex?

The carry trade is very common in the forex market. It is a case when a trader makes, or sells, one currency with a low-interest rate to buy another currency with a higher interest rate.

The trader is paying a low-interest rate on the taken currency while gathering the return on the higher interest rate of the currency bought. The contrast is known as the interest rate differential.

carry trade involves taking money cheaply from a country with a low interest rate and investing it into the country with a higher interest rate. 

Of course, this is a clarified example and in reality, the interest rate you pay or receive will be distinct and depend on how big your position is and any commissions & costs from the bank or broker you are applying to.

How forex carry trade works?

When trading forex with a broker..all positions are technically closed at the end of each day, even though the market is open 24/5 5. The broker will close and reopen your position and then ..either credit or debit you with the contrast in the overnight interest rate of the currency you have sold and the currency you have purchased. This is called ‘rolling over’ or ‘carrying’ a position to the next day.

MT swap values

If you opened and closed a trade on a forex pair on the same day.. then there is no ‘carry’ to pay, you will not be credited or debited any interest rate payments overnight.

There are two kinds of carrying trades in Forex: positive and negative

Positive carry trade definition

A positive carry trade involves taking a currency with a low interest rate.. while purchasing a currency with a higher interest rate. The trader will then receive interest rate payments formed on the interest rate differential between the 2 currencies and the size of their position.

Negative carry trade definition

A negative carry trade involves taking a currency with a high-interest rate while purchasing a currency with a low interest rate. The trader will suffer a loss on the interest rate differential and have to pay interest for holding the position.

It is important to note that.any gains made in a carry trade may be offset by the depreciation in the price of the market you are purchasing. Contrarily, any losses made in a carry trade may be offset.by the appreciation in the price of the market you are purchasing. 

Risks of carrying trades

There are risks related when using a carry trade strategy. For example, a country with a low-interest rate has a low interest rate for a reason. Typically, large banks will keep interest rates low when the economy is struggling to encourage consumers and businesses to borrow, spend and invest to increase economic activity. When the economy starts to grow again..the central bank may start to increase interest rates to stop it from overheating, thereby affecting any carry trade.

The other risks of carrying trades include the appreciation or depreciation of the market you are trading. A trader may profit from a positive carry and receive positive daily interest payments.. if they went long, or bought a market, at a certain price. If they then exit at a lower price, the loss of the investment may surpass the positive daily interest payments, resulting in an overall net loss.

Risk management in carrying trade strategy trading is vital. Using stop-loss orders can help save your capital from bad market movements.

About Marketsbloom:

Markets Bloom is a trading academy consisting of former trading industry professionals. We aim to help all types of traders looking to trade in the financial markets.

By registering with us..you will gain amazing insights into common issues traders face as well as how to instantly improve your trading approach. Our team of experts will be with you every step of the way on your journey to becoming a better trader.

For more information on our services contact us

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