What is carry trade

To carry means to hold. Carry trade is profiting from holding an asset whereby one asset is exchanged for another at a cost.

In actual sense when we talk of carry trade, it means borrowing and selling of financial instruments such as currencies with lower interest rate to buy currencies or other financial instruments with higher interest rate to profit from their interest differentials.

When you sell/borrow a currency or a financial instrument with low interest rate while buying another with a higher interest rate, you are paid interest for investing/ holding currency with a higher interest rate. And this is termed as carry trade.

For example, let’s say you are holding a certificate of deposit with your bank amounting to $10,000 and being given interest worth 2% per year, then on making research you realize you can invest with Newzealand bank at a rate yielding 4% per year. So you sell off your certificate of deposite and you invest in a higher yielding investment. By doing so you have done carry trading.

Another way would be borrowing money from the bank let’s say $5000 at 2% interest and then lend it out to someone else at a higher interest forexample 5%. You take 3% as your profit after paying back your debt.

Carry trade requires you to sell/ borrow financial instruments with low interest rates so that you are able to finance/ purchase instruments with high interest rates.

This simply means that; as an investor or a trader, you will profit from the interest differentials.

Interest rate differentials; by subtracting the lower interest rate from higher interest rate for the involved currencies or assets. The interest rate used is the one for the prevailing inter-bank deposit rates for the time during which the carry trade will be kept.

When you get a profit after taking the difference that will be a positive carry whereas https://www.freeforexcoach.com/how-to-read-forex-quotes/.  when the difference is a negative, it becomes a negative carry.

When it comes to carry trade in the currency market, I should say it is very popular especially to the big market makers such as banks, hedge funds and big institutions which may not be such of a big deal to small independent traders because it requires one to hold a trade for a long time to profit from it. (like 1 month to 1 year). Therefore this is not common to short term traders though it is applicable.

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