Taking advantage of carry trade means buying a higher-yielding currency against a lower-yielding one. This means that you earn from the positive interest rate differential when you buy a currency that offers higher interest and short a currency that offers lower interest. This will allow you to make profits as you hold on to the trade for days even if there's not a lot going on in price action.
Let's take a look at an example. When you buy the Australian dollar and sell the euro, in effect shorting EUR/AUD, you can be able to earn a positive interest rate differential of 2%. This assumes that the RBA still gives an interest rate of 2.50% while the ECB offers a 0.50% interest rate. With a good account size and enough leverage, you can earn from compounded interest if you hold on to the trade for more than a day.
What really happens with your broker is that they close positions at the end of the day and reopen them the next day for as long as you haven't exited the trade. This happens very quickly so you won't really witness it on your trade platform. In effect though, the interest for the day gets added or subtracted from your account, depending on your trade position.
This means that if you are holding on to a long-term position on a currency pair that offers negative carry, you can also be losing even if price doesn't move at all. For instance, if you short the New Zealand dollar against the U.S. dollar and you held on for a day, you can get a rollover of -1.50% if the Reserve Bank of New Zealand offers 2.00% interest while the U.S. Federal Reserve gives 0.50%.
Traders take advantage of positive carry when risk is on. In this scenario, traders are buying up higher-yielding currencies as they pursue more risk and reward. Not only do you earn from the trade itself as it goes in your favor, but you also incur additional interest on the positive carry. However, when risk appetite is down and traders are selling higher-yielding currencies as they seek safe-haven ones, you might be able to earn from positive carry but your wins will be erased by your losing forex position.
The bottom line is that you have to remember two things when trying to benefit from carry trade. Firstly, you have to buy a higher-yielding currency or one that has a higher interest rate and sell a lower-yielding currency or one that has a lower interest rate. Secondly, you need to make sure that risk appetite is up so that you can also earn from a winning forex trade on top of a positive interest rate differential.
Let's take a look at an example. When you buy the Australian dollar and sell the euro, in effect shorting EUR/AUD, you can be able to earn a positive interest rate differential of 2%. This assumes that the RBA still gives an interest rate of 2.50% while the ECB offers a 0.50% interest rate. With a good account size and enough leverage, you can earn from compounded interest if you hold on to the trade for more than a day.
What really happens with your broker is that they close positions at the end of the day and reopen them the next day for as long as you haven't exited the trade. This happens very quickly so you won't really witness it on your trade platform. In effect though, the interest for the day gets added or subtracted from your account, depending on your trade position.
This means that if you are holding on to a long-term position on a currency pair that offers negative carry, you can also be losing even if price doesn't move at all. For instance, if you short the New Zealand dollar against the U.S. dollar and you held on for a day, you can get a rollover of -1.50% if the Reserve Bank of New Zealand offers 2.00% interest while the U.S. Federal Reserve gives 0.50%.
Traders take advantage of positive carry when risk is on. In this scenario, traders are buying up higher-yielding currencies as they pursue more risk and reward. Not only do you earn from the trade itself as it goes in your favor, but you also incur additional interest on the positive carry. However, when risk appetite is down and traders are selling higher-yielding currencies as they seek safe-haven ones, you might be able to earn from positive carry but your wins will be erased by your losing forex position.
The bottom line is that you have to remember two things when trying to benefit from carry trade. Firstly, you have to buy a higher-yielding currency or one that has a higher interest rate and sell a lower-yielding currency or one that has a lower interest rate. Secondly, you need to make sure that risk appetite is up so that you can also earn from a winning forex trade on top of a positive interest rate differential.
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