The currency market is very versatile and highly volatile global market where an investor and traders always have an opportunity to make money out of the market irrespective of the dominating power whether it is born who are in control of the market or bulls a trader can always make money out of the market by keeping their trades in the dominating force direction. In a continues and strong trend and rising or falling interest rates scenario in one direction carry trade comes in the picture as they have all the required tools to get benefited by the movement of the market. Carry trade is a highly popular trading strategy which is widely used in the currency market where a trade is kept in a high yielding currency against the low yielding currency or buying the high yielding currency and going short on a low yielding currency.
Japanese yen is one of the most attractive currencies to trade with Australian dollar or New Zealand dollar as the interest rate spread in this currency pair’s are much higher with enables a trader to get benefit with the carry trades by earning interest along with the movement of the currency pair. In order to select a profitable carry trade one have to find the high yielding currency and also the lowest interest yielding currency to select the perfect pair to trade for the carry trade. This selection process not only considers the interest rate factor and yield but it also considers other fundamental and technical factors to increase profitability and accuracy of trades.
Here are the interest rates for the most liquid currencies in the world:
Australia (AUD) 1.50%
New Zealand (NZD) 1.75%
Canada (CAD) 1.75%
U.K. (GBP) 0.75%
U.S. (USD) 2.25%
Swiss franc (CHF) -0.75%
Japanese yen (JPY) -0.10%
By keeping in mind these interest rates a trader can mix and match the currencies with the highest and lowest interest rates yields and enter in a carry trade. However, interest rates can be changed at any point time so forex traders should always stay updated with the recent developments in the interest rates. Since New Zealand and Australia along with Canada have the highest interest rates yields and Swiss Franc has the lowest, it is hardly surprising that AUD/CHF and NZD/CHF is currently the most popular pair for the carry trade. In Forex market currencies are traded in pairs so this gives the trader a perfect environment to benefit from the yield spread between tow currency pair. The Japanese yen’s low borrowing cost is a very unique advantage that is widely used by equity and commodity traders around the world.
How carry trade works
The main attraction in the carry trade is the ability to earn interest by using the spread between two currencies. The interest is earned in a carry trade by triple rollover is given on Wednesday to calculate for Saturday and Sunday carry position in the simple word a trader can earn interest by keeping a position open which uses the yield spread positively. Carry trades makes money not only by earning interest but the movement of the currency pair also tends to add the value of a carry trade.
However, the primary goal for a carry trade is to earn interest by using the gap between two countries interest rates by trading the currency pair with offers the highest yield.
The perfect market environment for a successful carry trades is a range bound or low volatile environment as the market tends to increase its risk appetitive in low volatility in order to earn money out of the market with pushes a lot of new traders to jump in the market. A carry trades always look for high yields but a positive capital appreciation gives the trader an increased advantage in the trade.
Majority of carrying traders, especially the big institutional investors and hedge funds with a large exposure in the market prefer to trade in a low volatile environment and they tend to increase their exposure at times of sideways market movement this is also called as an accumulation of assets. In a low volatile market carry traders always remain happy because they are not looking for the profits made because of the market movement but there main focus is on yields and as long as the currency stays in a range or increase its value a carry trade always remain in profits because they are getting paid by the interest rate accumulated by holding the position in a carry trade
Carry trades and Increasing Interest Rates
Carry trades are a very useful tool to earn interest in both increasing and decreasing interest rate atmosphere. Carry trades work when central banks either increasing interest rates or plan to increase them and vice versa. Money tends to move from low interest giving country to a high interest paying country, and big institutional investors tend to move a huge amount of funds in order to get a higher return on their investment via interest. The carry trade not only attracts traders who are searching for high yield but also the investors who are looking for capital appreciation tends to get attracted by the growth potential of a carry trade.
In an increasing interest rate scenario the central bank increases the interest rates and investors and trades can be seen adding there same carry trades which will in turn pushes the value of the currency of that country higher and make it more valuable the secret to getting the most out of the market in the increasing interest trade scenario is to get in a carry trade in the last stage of rate tightening cycle so that you can enjoy the high tides of interest trade and get out of the market at the starting of the interest rate peak.
Carry Trades and Reducing Interest Rates
In a falling Interest rate scenario the profitability and reliability of a carry trade comes in to questions when the countries that used to offer high-interest rates starts to cut the interest rates or slowly starts to reduce the interest rates than the money used to flow in a higher interest giving country and that makes the profits of a carry trade in that currency under pressure. This initial shift in the interest rates and monetary policy tends to affect the value of a countries currency which tends to reflects in the market movement of that country’s currency. to earn profits form a carry trade a trader needs to find a high yielding and slow upward moving currency pair in a successful carry trades the selected currency pair need to be either low volatile or in a bullish trend.
However whenever the interest rates start to fall or the central bank decides to decrease the interest rates, foreign investors and institutional investors and traders tends to shift their funds from that country and are less compelled to go long that countries currency and look out for a high yielding economy which offer a high interest rate elsewhere for more profitable opportunities. When this situation happens, demand for the relative currency tends to fall which creates a huge sell-off in the currency value.
Central Bank and carry trades
A restrictive policy of a particular central bank also tends to affect the carry trade negatively as carry trades tend to fail whenever a central bank takes restrictive actions to prevent a falling or rising local currency with have a large impact in the profitability of a carry trade. For an export-oriented country, an excessively strong currency or a strong bullish trend in the local currency can result in a fall in the profitability of the local experts, on the other hand, a week currency can result in a drop in margins of a foreign companies working domestically.
How to be Benefiting from the Carry Trade
Forex is a global market and in the world there is always a central make with is increasing or decreasing the interest rates and a carry trade is a highly effective tool to get benefited from the spread or difference in the interest rate yield of different countries by trade the currency pair of those country with the help of a carry trade.
To be a successful carry trades or investor a trader should not only look of a currency with is offering a high yield and other currency with is offering the lowest yield but a trader should also pay attention to the other currency pairs which offer the same positions of currency and should always trade a basket of trades. It is always a good idea not to put all your eggs in one basket and in carry trade also a trades should diversify the trades to avoid any huge loss due to a sudden movement in the market.
With a basket of currency that includes three or more highest and the three or more lowest yielding currencies, a trades can make an effective carry trade strategy with can help them in making money out of the market in adverse market conditions. Because the carry trade portfolio not only depends on only one currency pair but the risk and return can be diversified by trading a basket of currencies so even if a carry trade fails the other trades can compensate the loss and manages to give positive returns.
By looking at the characteristics of carry trade we can clearly see that a carry trade is not a trading strategy instead it is an investment strategy as it involves a long-term investment in a currency pair. The carry trade is suitable for long-term investors who are looking for capital appreciation and earning interest. The concept of a carry trade is to earn interest while you hold a position the carry trade strategy a long-term investment strategy with is widely used by investment banks and institutional investors who invest a huge amount of money in the market and focuses on a steady return rather than a sudden movement.