Trade Forex Trading

FX Carry Trading: Long Term Strategy - What is it?

Carry Strategy is one of the long term investment strategy used. It is the use of interest rates differences to profit from currency trades.

Example of a Carry Strategy on GBPJPY Currency Pair

Example of a This Strategy on GBPJPY Pair

A carry trade is when a currency with a lower rate is sold to purchase a one that pays a higher rate. The difference between the two currencies is called the interest rate differential.

When traders choose a currency pair, they opt for one that offers a higher interest rate, purchasing the higher-yielding currency and selling the lower-yielding currency to profit from the differential.

This strategy involves two currency pairs. You buy one and sell the other at the same time. Pick the pair with the higher interest rate to buy and the lower one to sell.

Take the GBPJPY chart above as an example. It showed a clear carry trade chance. GBP offered about 5% interest, while JPY gave just 0.5%.

The difference was 4.5%, this difference propelled the GBPJPY upwards for a total of 87 months about 7 and half years. The currency pair moved a total of 10,200 pips which is equivalent to 102 cents, 100 pips = 1 cent.

The upward trajectory is attributed to the profitability of holding GBP compared to JPY, which offers investors a 4.5% interest rate advantage. Conversely, if an investor opts to sell GBP for JPY, they would incur a cost of 4.5% from their own funds.

Following this carry trade activity, a carry unwinding process ensued subsequent to the 2008 recession, during which the UK economy slashed the interest rate for GBP down to approximately 0.5% to stimulate economic expansion (and encourage quantitative easing): this rate was nearly equivalent to that of JPY, eliminating any significant difference or profit potential from purchasing GBP against JPY. This phenomenon is termed Carry Unwinding: some market participants might also label it negative carry.

Carry Example: Using AUDJPY

If the AUD has an interest of 5 %

And

The JPY has interest of 0.5 %

Then we can use this difference to carry the AUDJPY

The question is how to implement this strategy

First we shall buy the AUDJPY

This will mean that we now have bought AUD and simultaneously sold JPY.

Because we have bought AUD, we shall be paid the a rate of 5%.

At the same time we have sold JPY, we shall pay an a rate of 0.5%.

Note: When you purchase a currency, you earn interest: conversely, selling a currency incurs interest payments.

For AUD we get paid 5% per year

For JPY we pay 0.5% per year

Since we get paid 5% and we pay 0.5% the difference (profit) is 4.5%.

This difference is what is called the carry trade - Exploiting interest rates difference to make a profit on top of the profit that you get from pips. This is like double profit.

With this strategy we always buy the higher interest rate currency & sell the lower rates one for a positive yield. If your trade is in the opposite trend direction then you'll be the one paying the interest. Using the this method is a great way to earn excellent rates of return on your investment, profit from the rates and also the capital gain from the transaction also.

A carry trade lets you earn big profits in the market. It works best with borrowed funds. The example below shows how borrowed funds boost gains from this kind of investment.

Examples

Using the AUDJPY example above:

If you have $50,000 and buy the AUDJPY for 1 year you will get 4.5%

Interest for that year.

4.5% of $50,000= $2,250

The profit realized from $50,000 isn't substantial, but when Forex leverage is applied, the earnings will increase significantly.

Example 1: Leverage 5:1

Now what if we use Leverage of 5:1

You have $50,000 add the leverage= 50,000*5= $250,000

Now if you have 250,000 then 4.5% of this money=

4.5% of $250,000= $11,250

Profit = $11,250

Capital = $50,000 dollars

Return = 11250/50000= 22.5%

Example 2: Leverage 10:1

Now what if we use Leverage of 10:1

You have $50,000 add the leverage= 50,000*10= $500,000

Now if you have 500,000 then 4.5% of this money=

4.5% of $500,000= $22,500

Profit = $22,500

Capital = $50,000

Return = 22500/50000= 45%

When you leverage your money when placing the trades the profit from your money will also then be multiplied. Its best to keep leverage below 5:1 because these is a long term strategy, and buy when price is close to upward trend line where there is a good risk: reward ratio.

In the example shown above, leverage boosts profits. A 10% leverage ratio turns that trade into a 45% yearly gain. This skips capital gains like pips profits. Check the Factors of Carry topic for key details to consider.

Popular Currencies for this strategy

The most Popular Currencies are the Yen Currency Crosses, These are:

GBP/JPY - Great Britain Pound vs Japanese Yen

AUD/JPY - Australian Dollar vs Japanese Yen

NZD JPY - New Zealand Dollar vs Japanese Yen

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