Guest Post by ForexTraders.com
If you’re going to learn about just one market-moving catalyst when it comes to foreign exchange trading, history shows it should be interest rate decisions by the world’s major central banks that move currency market more than any other news event. The reasoning behind this is pretty simple. The forex market typically views a currency from a country with high interest rates as more valuable than a currency from a country with low interest rates. That may be simplifying things a bit, but the fact is forex traders need to know when interest rate decisions are coming because being unprepared can mean you miss some great pip-making opportunities.
One way to take advantage of interest rate decisions and more importantly, discrepancies, is by using the carry trade. Before you start executing carry trades, you obviously need to know what a carry trade is and if your forex broker will allow you to put a carry trade on. Many of the best forex brokers allow their clients to use this strategy. After all, forex brokers make money on every trade you place and they’re not going to discourage you from using one strategy over another. With that, let’s take a more detailed look at exactly what a carry trade is.
As we said earlier, the primary objective of the carry trade is to exploit differences in the interest rates of two countries. The most often used pairs in the carry trade are the Australian Dollar/Japanese Yen (AUD/JPY) and the New Zealand dollar/yen (NZD/JPY). The carry trade has been around for more than two decades, but only recently joined the commonly used forex lexicon. The reason for this is because the Bank of Japan has kept interest close to zero for more than a decade while the Reserve Banks of Australia and New Zealand have raised their interest rates to combat inflation in their rapidly-growing economies. Other pairs to carry trade with are GBP/JPY and GBP/CHF, but only when interest rates are high in the U.K.
Essentially, a carry trade means you use a low-yielding asset like yen to buy a high-yielding asset like the Aussie dollar. Now the best part of the carry trade is you don’t even need the currencies in the pair to move because you’re earning interest for as long as you hold the trade. Think of your carry trade as high-yielding savings account. This how you garner interest. Let’s say Australia’s interest rate is five percent and Japan’s is one percent. Take the difference, four percent, and multiply it by the value of your trade. Then divide that number by 365 (the number of days in a year) and the result is the amount of interest you’ll earn on a DAILY basis.
You could earn more interest in a week-long carry trade than you could in a year with a traditional savings account, so as you can see, the carry trade is a powerful tool that all forex traders should have in their arsenal. So don’t ignore the carry trade and make sure you’re trading with one of the best forex brokers that can help you with your carry trading strategy.
Share
