How does carry trade work in the forex market

You are often told or may be the first time you enrolled here at freeforexcoach  you learnt that currency is only traded in pairs. For instance when you choose to buy or sell a pound, it always has a counter currency. This means without a counter currency your trade cannot happen. What do I mean?

A currency pair contains a base currency and a counter currency. Forexample GBP/USD, USD/JPY or NZD/USD and so many others.

So when you choose to buy GBP/USD or any currency pair, you are actually buying GBP at the same time selling USD at a fixed contract size and the exchange rate at  that period. By doing so, you are borrowing the USD to purchase the GBP.

Like we said, with carry trade, you benefit from interest differential. With currency trading you pay interest whenever you sell a currency and you are paid interest for holding/buying a currency.

If the currency you bought has a higher interest rate than the one you sold, you have a positive carry trade, if it is less then you have a negative carry trade.

Currency carry trade is therefore borrowing or selling currency with lower interest rate to purchase or finance a currency with a high interest rate.

With carry trade you make money  even when the price of the pair stays the same during the time you are in the forex carry trade. Incase the trade moves to your favor during the time of carry trade, you will not only earn carry interest but also capital appreciation of currency.

Carry trade has also got some risks involved especially when you take a trade and price goes against you . It’s likely to wipe off all your earned interest due to fall in value of currency and the leverage used incase any. So you don’t have to open a trade just because of its interest differential but you should first consider the available market conditions for the pair. Forexample the level of risk in the market by the traders, major fundamental factors and  technical factors.

Inorder to benefit from carry trade, chose a currency pair that is stable  and should be in an uptrend favouring the high yielding currency.

Unlike other investment assets, spot forex market closes at the end of the day and rollover is automatically done on open positions held at that time. The market normally closes at 5 pm, New York time or 9 pm GMT and the new day officially begins. Because you are holding positions overnight, you always receive interest on the currency you bought  and pay interest on the currency sold, the difference is either credited or debited on your account by your broker.

Brokers credit or debit the difference to your account as they re- open your positions by adding or subtracting pips to the trade.

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