Taking advantage of carry trade means buying a higher-yielding currency against a lower-yielding one. This means that you earn from the positive interest rate differential when you buy a currency that offers higher interest and short a currency that offers lower interest. This will allow you to make profits as you hold on to the trade for days even if there's not a lot going on in price action.
Let's take a look at an example. When you buy the Australian dollar and sell the euro, in effect shorting EUR/AUD, you can be able to earn a positive interest rate differential of 2%. This assumes that the RBA still gives an interest rate of 2.50% while the ECB offers a 0.50% interest rate. With a good account size and enough leverage, you can earn from compounded interest if you hold on to the trade for more than a day.
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.
This means that if you are holding on to a long-term position on a currency pair that offers negative carry, you can also be losing even if price doesn't move at all. For instance, if you short the New Zealand dollar against the U.S. dollar and you held on for a day, you can get a rollover of -1.50% if the Reserve Bank of New Zealand offers 2.00% interest while the U.S. Federal Reserve gives 0.50%.
Remember also that risk sentiment must be on your side when taking advantage of carry trades. This means that market sentiment should be favoring a rally of higher-yielding currencies versus lower-yielding ones, as traders would rather take on more risk. This way, you can have positive returns from your forex trade and add to your wins with the positive interest rate differential. On the other hand, when risk is off and higher-yielding currencies are selling off, you can still earn from positive carry but lose on your 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.
Let's take a look at an example. When you buy the Australian dollar and sell the euro, in effect shorting EUR/AUD, you can be able to earn a positive interest rate differential of 2%. This assumes that the RBA still gives an interest rate of 2.50% while the ECB offers a 0.50% interest rate. With a good account size and enough leverage, you can earn from compounded interest if you hold on to the trade for more than a day.
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.
This means that if you are holding on to a long-term position on a currency pair that offers negative carry, you can also be losing even if price doesn't move at all. For instance, if you short the New Zealand dollar against the U.S. dollar and you held on for a day, you can get a rollover of -1.50% if the Reserve Bank of New Zealand offers 2.00% interest while the U.S. Federal Reserve gives 0.50%.
Remember also that risk sentiment must be on your side when taking advantage of carry trades. This means that market sentiment should be favoring a rally of higher-yielding currencies versus lower-yielding ones, as traders would rather take on more risk. This way, you can have positive returns from your forex trade and add to your wins with the positive interest rate differential. On the other hand, when risk is off and higher-yielding currencies are selling off, you can still earn from positive carry but lose on your 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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