No trader should jump in the market without a trading plan, not if he wants to succeed at it. A trading plan is a list of rules and specifications about your risk management, the patterns that indicate an opportunity and a trading strategy. Every strategy will depend on the price movements and where are they going next, so we have to know exactly how we are going to be placing that order, how long it is going to stay there and how much we expect to receive from it.
Some people day trade, others prefer scalping and others simply invest in an asset thinking of a long term profit. In this opportunity, we are going to be talking about carry trading.
Disclaimer: this post shouldn’t be considered investment advice and it is just for educational purposes. We are not responsible for any trades you make following this guide.
What is carry trading?
Carry trade is a strategy traders often use when trading currencies in a particular market. This strategy is about buying currencies at a certain price and sell another at the same time, so while we are selling a currency, we are financing ourselves to be able to invest and buy money in a different currency.
This strategy consist on buying a currency with a high interest rate and simultaneously selling another currency with a lower interest rate. It is a commonly used strategy to receive profits from the price variations between the assets and we can see it frequently among Forex traders.
The profits will come from the difference between the interest rates of both currencies, which normally varies depending on the chose leverage level. Since interest rates are the responsible ones for giving us the profit, it can be obtained even if there is no greater variation in pips.
How does carry trading work?
Assuming that the Canadian dollar (CAD) offers an interest rate of 4.75% while the Swiss Franc (CHF) offers a rate of 0.25 percent. Therefore, to carry out a carry trade, a trader must buy Canadian dollars and at the same time sell Swiss francs. By doing this, you can make a profit of 4.50%, which is equal to 4.75% interest earned with the CAD minus 0.25% interest paid by the CHF, as long as there is no significant variation in the exchange rate between both currencies. In this case, the benefits are based on zero leverage, since a leverage of 5x is equivalent to 22.5% only in interest rate differential between two currencies.
How to place carry trading orders?
Example:
- Buy Canadian Dollars (CAD) and sell Euros (EUR). This is equivalent to opening a long position in CAD / EUR.
- CAD buying position: The trader makes a profit of 4.75%.
- EUR Sell Position: The trader must pay 0.25%.
- If the interest rates are kept constant while the positions are kept open, the profit is 4.50%, that is 450 base points.
If multiple traders choose to do the same strategy with the same pair it will most likely cause the price to increase, giving you a profit in pips as the price go up and not only on interest rates. This is usually the best scenario for the carry trading strategy.
These traders often works because of how currencies will be exchanged among different countries with their determined interest rates, which will also decide what countries get more investment over others.
