Among Forex trading strategies the carry trade one of the best of them

Among Forex trading strategies, the carry trade is among the best of them. Here is what it represents and how to implement it.

The carry strategy

The carry trade is one of the oldest professional strategies on the foreign exchange market. It has existed long before the floating exchange system. This is an arbitrage strategy that consists of benefiting from the interest rate differential between two currencies.

The basic operation of the carry trade is to borrow a currency with a low-interest rate. And to invest the borrowed amount in a currency with a higher interest rate. The proponent of this strategy will therefore cash the interest rate differential applied to the amount borrowed and invested between the borrowed currency (the “funding” currency) and the investment currency (the “carry” currency).

Profitability of the carry trade

It’s the difference between the money market investment gain of the currency you bought minus the cost of borrowing the currency you sold.

The interest rate specific to each currency welinks to the interest rate charged by the central bank of the country concerned. Of course, you will not apply the policy rate. But you must take into account the overnight money market rate. Which is itself directly under influence by the central bank policy rate.

Once one initiates the carry trade transaction, each evening, you earn the difference between the interest rates of the two currencies in question. Your Forex broker will be responsible for passing on the credit interest or debit interest on your Forex account balance.

You must keep in mind that for the interest to be credit, the rate paid (the rate at which you borrow currency A) must be lower than the rate received (the rate at which currency B is placed)

Example of the carry trade

In this example, we choose the Euro (EUR) and the British Pound (GBP). The current interest rate of the European Central Bank (ECB) is 1%, and the Bank of England (BoE) interest rate is 0.5%.

Always use a Forex compounding calculator in this case which naturally helps you to calculate any compounding rate in the currency market.

When you go to buy the EUR / GBP currency parity, you then place the euros on the Eurozone market. And you borrow the British Pounds on the British money market at a rate close to that practiced by the Bank of England (BoE).

More specifically, when you buy the Euro Pound Sterling (EUR / GBP), you are buying Euro and selling Pound Sterling.

Daily interest (calculation occurs each evening by your Forex broker) will then be received if the position is overnight. That is to say, it is held beyond a single trading session.

It is, in fact, every evening that your Forex broker credits or debits your account. And it considers the interest rate differential between two currencies of the pair..

You can consult your central bank interest rate section to find an attractive interest rate differential.  And carry out a carry trade on your Forex account.