What is a foreign exchange carry trade?

Carry trade is one of the most popular fundamental trading methods, which refers to buying high-interest currencies and selling low-interest currencies, and depositing the purchased high-interest currencies in the country's banks to earn higher interest rates than low-interest currency countries. Therefore, during the entire trading process, traders may not only make profits, but also have intermediate interest margin income.

In addition, because of the leverage involved in the transaction, the overall currency trading volume is relatively large, so for the trader, the long-term interest margin is also an objective income. The carry trade starts by converting the low-interest currency into the high-interest currency, and ends by depositing the high-interest currency in the country's bank Financial Institution Group.

There are two types of carry trades:

One is to directly exchange the low-interest currency held by oneself into high-interest currency and deposit it in the country's banking institutions.

The second is to borrow from a low-interest currency country, and then convert the borrowed low-interest currency into a high-interest currency and deposit it in the country's banking institutions. The impact of the carry trade on the foreign exchange market. When the carry trade opens a position, because it is buying high-interest currency and selling low-interest currency, then the high-interest currency will strengthen and the low-interest currency will weaken. When the carry trade is settled, because it is selling high-interest currency and buying low-interest currency, the high-interest currency will weaken and the low-interest currency will strengthen.

Detailed interpretation of carry trade

While you pay a low interest rate on the instruments you borrow or sell, you are earning a higher interest rate on the instruments you buy. Therefore, your profit comes from the interest rate differential between the two financial instruments.

For example: Suppose the exchange rate of the dollar against the yen today is 112 yen, trader A buys 100,000 dollars, sells the yen 11.20 million, and deposits the dollar in the US banking institution, such as trader A buys back the yen after one year, and the exchange rate remains unchanged, trader A will profit from this: Suppose the interest rate of the dollar is 3%, the interest rate of the yen is 0.1%, trader A will get interest income of 10X3% = 3,000 dollars, A will pay interest of 1120X0.1% = 11,200 yen, because the exchange rate remains unchanged, so 3,000 dollars = 0.3X112 = 336,000 yen, the interest difference A will get is = 33.6-1 = 324,800 yen. So A gains 324,800 yen for holding the high-interest currency US dollar for one year, (ie 2,900 US dollars). If the US dollar appreciates, A will profit from the exchange rate rise in addition to the interest profit; even if the US dollar depreciates, as long as the depreciation does not exceed the interest difference, A can still profit (but it will be less than the profit when the exchange rate remains unchanged).

The risk of carry trades

Any kind of transaction is risky. In the process of carry trade, the fluctuation of interest is not too large, because a country's banks have to consider lowering interest rates or raising interest rates for a long time, so it has little impact on interest income changes. The main risk comes from the exchange rate change of high-interest currencies against low-interest currencies. Of course, although currency interest rates do not fluctuate too much under normal circumstances, it is not suitable in times of crisis, because then the interest rate spread will change more frequently and the risk is relatively large.

In general, carry trades take a long time to execute, and some institutions only trade several times a year. Since fundamental analysis determines the long-term trend of the currency, trading is more likely to be profitable, and there is a double profit.

Therefore, it is very popular with some institutional traders.

How to make a carry trade?

The carry trade is another example offoreign exchange marketThe way to make money is not to buy low and sell high. Daily buying low and selling high can be a big challenge for traders. Carry trading strategies work best when traders feel risky and are confident enough to buy high-yielding currencies and sell low-yielding currencies. Current economic indicators may not be good, but the economic outlook needs to be positive. If a country's economic outlook is bad, no one wants to risk buying that country's currency.

In simple terms, carry trades are best conducted when investors' risk aversion is low. When risk aversion is high, carry trades are difficult to guarantee. When risk aversion is high, investors are not willing to buy high-yielding currencies, or tend to reduce their positions in high-yielding currencies. When economic conditions are uncertain, investors tend to put their funds in safe-haven currencies with lower interest rates, such as the US dollar and the Japanese yen. Finding the right currency pair for carry trades is very easy.

As long as the following two points are met, we can consider a carry trade:

1. Find currency pairs with high interest margins.

2. Find a currency pair that remains stable, or finds a currency pair that is in an uptrend and has a high-yielding currency that continues to appreciate in the currency pair. The spread through carry trades is not as exciting as the gain due to market volatility.

However, when you apply the carry trade to the foreign exchange market, it is also exciting to see your account funds increase every day due to the high leverage of foreign exchange trading and the daily payment of interest rates. Economic and political factors are changing the world every day. It is also possible that the spread factor between currencies will change, which could prompt the popular carry trade.

Therefore, when making a carry trade, you should place a stop loss just as you would a general directional trade.

The purpose of this article is to explain the relevant concepts and does not constitute any investment advice. The foreign exchange market is risky and investment needs to be cautious.