Carry Trade In Forex Trading | Forex Trading Strategies
In the Forex market, there is a common method of trading known as the carry trade which is made in relation to fundamental analysis
. It should be a common term once a trader has studied their fundamentals and learned how to apply the knowledge they have gained. Still, many traders do not understand what a carry trade is or how to use it because they may have only focused on technical analysis rather than fundamental analysis.Before a Forex trader decides whether they can make a carry trade, they must first evaluate different currencies and the economic conditions in their associated countries. This is the basics of fundamentals and interest rates are probably the most important of these basics.
In a carry trade, Forex traders try to get a better idea of the true value of a currency through various news reports, political events and economic statistics. Then the carry trade can be used as a good strategy based on the interest rates in a particular set of currencies.
The basic idea is that, when a trader decides to sell a currency with lower interest rates, they can also purchase a currency thats offering higher interest rates. They sell the low rate and they buy the high rate. This is also similar to what is known as hedging and comes from the gambling term hedging your bets. By taking two trades in opposite directions, a Forex trader uses the strategy of capturing the difference of two different rates.
A real example of this has commonly been known as the Yen carry trade. When Japan began decreasing their interest rates in 1999, they eventually got to where they were almost at zero. This was essentially a great loan to get in on and investors would take the money they got from their easy loan and use it to buy something else later on.
To make the idea simple, just suppose that the interest rate for loan in US was 2%. Then imagine that the same loan in another country was 5%. You could take advantage of the difference in these two rates of interest by taking out a loan with the 2% interest rate in the US and simply exchanging the money into Australian dollars. Then, if there was no fluctuation in the market, the trade would earn you a profit of 3%. You never used any money of your own to begin with and you ended up keeping 3% of the original loan you got! This is called a carry trade. You literally carry your loan from one place to another and the trade you make results in a profit.
Of course, you wouldnt want to get carried away! These kind of trades still have a risk involved. Exchange rates can fluctuate while you are moving your money from one place to another. For example, the country with the 5% interest rate could suddenly see a weakening of its currency due to political turmoil or a sudden announcement from their central bank.
Investors are often very careful with carry trades so as to research the market beforehand and make sure there are no major news events coming out that day or week. Then they go ahead and hedge their bets as they trade the loan from one currency into another. Make sure and understand the risks in Forex trading before you get involved with high leverage trading. Then you will find the carry trade to be a very promising way to make a quick profit!
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