Carry trade is a pretty unusual low-risk trading strategy that boasts the ability to generate profits over a long period of time. If you do internet research on carry trading, you’ll only find scare information without any examples, screen shots and detailed explanations.
Before reading the article and writing your questions in comments section, I recommend to watch this video. It’s not long, but covers biggest part of questions on the topic.
Aiming to fill in this gap, we provide a step-by-step guide to using this amazing strategy so that any trader can benefit from it.
What is a carry trade, or how to beat the system?
Carry trading emerged in the 80s of the XX century. The best thing about this trading technique is that it can generate profits for years! Plus, it won’t take much of your time. You only need to check your trading charts once a day.
Carry traders are buying a national currency with low interest rate and invest it in the currency with a higher interest rate.
This is the most common definition of carry trading. Sounds too vague? Let’s break it down!
Suppose, you go to the bank and take a loan at 8% interest rate. Then you go to another bank and use this money to make a deposit at 12% per year. In this case, you can pay your interest to Bank 1 with your profits from Bank 2 and still have extra 4%. This is how you get a small profit without any effort! This is a very low-risk scheme as the worst things that can happen is that your bank goes bankrupt (which happens not that often, especially if you choose a reliable establishment).
While it may be difficult to implement this scheme with banks, you can totally do it in the Forex market. All you need is a deposit with a reliable broker and trading terminal installed on your computer.
Carry trading in Forex market and stock market
For this strategy, seasoned investors tend to use the Japanese yen (JPY) as it traditionally goes with the lowest interest rate. Until 2008, long-term traders would buy US dollars with Japanese yens and then invest the American currency in fast-growing stocks of major corporations. However, the 2008 financial crisis caused a significant shift in exchange rates, and the bubble popped.
Luckily, you can use any instruments for carry trading.
Despite significant differences between carry trading and other strategies, carry trading uses the classic “buy low, sell high” principle, just in a different interpretation.
Carry trading is so popular among Forex traders that it even affects exchange rates. However, to be able to use this technique, you must meet the following requirements:
- You must have a fat deposit (a couple dozens of dollars, at least). As carry trading involves low risks (unless you’re using a margin leverage), it also features pretty low profitability (up to 5% per month).
- You must know how to trade on high timeframes. Plus, you must be really patient. Keep in mind that currency fluctuations may generate losses for several subsequent days or even weeks! In this stressful situation, you must be able to tell a short-term price correction from a major trend reversal.
- You must know the basics of fundamental analysis and track changes in interest rates.
A carry trade is a long-term trade which is mostly used by professional traders as opposed to amateurs. However, we can give our readers a few tips on how to put this trading technique to work.
Carry trading: Case Study
To be able to open profitable carry trades, you first need to understand what a swap means.
A swap is the difference in interest rates between the two currencies you’re trading that occurs when you roll your trading position overnight.
When making a swap, a trader usually loses a part of his profit (negative swap). However, if the interest rate on the currency you’re selling is higher than the interest rate on the currency you’re buying, you earn a profit (positive swap).
The bigger the difference between the interest rates, the more money you can make. This makes the essence of carry trading.
How do you find a currency pair with a positive swap? This is where trading platforms come into play. For the purposes of this article, we’ll be using the MetaTrader4 platform as the most common popular tool among traders. Install MT4 on your computer. Find the “Market Overview” window. Click on any currency pair with the right mouse button. In the pop-up menu, select “Specification”:
How to find out whether a currency pair is right for carry trading?
As the USD/CHF currency pair has a positive swap for long positions, you need to find out whether you can hold a long position on USD/CHF long-term. To do this, let’s analyze how USD/CHF has been changing on a high timeframe:
On a weekly chart, the USD/CHF pair has been going up since the middle of 2011. This pair is characterized by low volatility. The trend even survived the infamous “Swiss franc shock” on January 15, 2015, when CHF strengthened against USD by -2,000 pips within 15 minutes. This means we can totally use the USD/CHF pair for carry trading.
To avoid possible losses as a result of market volatility (like the shock mentioned above), you should update your stop loss every day or every few days. Be sure to move your stop loss after the rising currency pair.
This is why carry trading requires a big deposit and vast trading experience. Plus, you must be psychologically ready to hold a position long-term.
Is carry trading the right choice for an intraday trader?
There is no denying that carry trading is a professional, time-tested trading strategy. Does that mean that you can add it to your toolbox?
It’s a common opinion that you steer clear of carry trading unless you have a many-year trading experience and 6-digit deposit in US dollars. Carry trading is traditionally viewed as a prerogative of hedge funds and PAMM managers. There is a grain of truth to it. Let’s face it: carry trading is not something any trader can afford.
However, if you’re ready to hold an open position for months and put up with lengthy losing streaks — knowing that the market will continue in the right direction after a correction — then carry trading is just what you need.
If you’re more of an active trader, you should check out our website for other great strategies. Remember that you can only achieve success when your selected trading system is in sync with your personality and your perception of the market.