There is one particular strategy that could generate returns over time, even though the price will not fluctuate. Today we will talk about the carry trade strategy, what you should know about it, how you could use some of the principles that we will discuss below in order to pick those currency pairs that have a higher potential for profit.
What is carry trade?
It is a forex strategy used by traders who keep positions for a long period of time and which generates returns based on interest rate differentials.
Let’s take an actual example so you can understand better how it works. In the forex market you are always trading two different currencies. You are basically borrowing one currency in order to buy another one.
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Since borrowing is involved, you need to pay an interest. Also, you receive an interest for the currency you bought. The difference between the interest you receive and the interest you pay is what could generate profits over time.
Now, you haven’t seen any interest in your brokerage account, but there is something you have most likely notices. We are talking about swap rates.
Swap rates are being calculated based on the interest rates practices by central banks and a positive figure would mean you will earn a small interest for each day you are holding your position.
How could you use carry trade to your advantage?
Traditionally, carry trade meant to open a position for long periods of time and the compounding interest would result in a substantial profit. However, that could be tricky since the gains from the interest rate could be erased by the price movement.
In this rapidly changing world, it is hard to say how a certain currency pair will perform over the next few years, so a different approach is needed.
Instead of keeping your trades for months in a row, you could use the advantage of positive rate differential for swing trading. Going short in pairs like the EURUSD, GBPUSD or trading long on USDJPY or USDCHF will mean you will earn extra money for each day you are holding the position.
It won’t be too much, but in this way you are able to increase your profitability and small gains add up over time. Make sure to take into account the swap rates next time you plan on trading a certain currency pair because it could really account for a significant part of your profits.