How to use forex carry-trade trading strategy to your benefit

Carry-Trade is an investment strategy that has obtained a wide spread support and admiration from traders in the various security markets. Whether you are trading currencies, commodities or equities everybody is raving about this strategy. Even though the strategy is certainly not new it has been getting a lot of attention in the recent years. To explore this strategy further lets start with a discussion what a carry- trade is and then move on to how it works and how it can benefit you. 
A carry-trade involves the purchase of a high yielding currency by funding it with a low yielding currency. Most commonly you see the currency pairs where there is significant interest rate spread in carry trades. Some of the common examples are AUS/JPY or NZD/CHF. So since the trade depends on the interest rates being offered by the various economies it’s important to find out about the currencies whish give a higher yield and the ones that give a lower yield. Traders can easily get this information by visiting the websites of the central banks of the various countries or by visiting DailyFX.com or other similar websites. The information will usually be presented in a tabular form with the interest rates being quoted as percentages. 

 The usual figures will indicate that Australia and New Zealand are usually the highest yielding currencies while the Japanese yen is the lowest. This information can be used to your benefit and all a trader will need to do is to buy NZD/JPY or AUD/JPY. The Japanese yen because of its low selling cost has always been a favorite with currency traders who are interested in a carry trade. 

 One of the biggest advantages of carry-trade is that besides capitalization gains you will also earn interest. Suppose if you are trading the NZD/JPY pair and if you are holding a long position your income will be accrued every day with Wednesdays being the triple rollover day to make up for the weekend rolls. So if you were to calculate your daily interest this is what it would look like this 

 Daily interest rate can be calculated as interest rate of the long currency minus interest rate of the short currency, divided by the number of days in a year, and times by notional of your position. 

 So if the interest rate offered by New Zealand would be 8% and the Japanese Interest rate would stand at 0.005% the approximate daily interest rate would be $20 

 The interest is earned by traders who hold a long position on NZD/JPY while traders who are fading the carry have to pay the daily interest. 

 However there is a catch to this extremely lucrative yet simple strategy. Traders who believe that carry-trade is only about buying a high yield currency by shorting the low yield currency will be sorely disappointed by the losses that they may have to incur. Since the profit depends on the average annual yield if the exchange rate depreciates more than average annual yield all the profits will be knocked off. If you are using leverage the effects and losses can be even more drastic. So it’s important to learn about the situations under which a carry-trade is beneficial and when it isn’t. 

 When the central bank of a country either increases the interest rates or plans on doing so you can expect the larger institutions and investors to move their currency from the low yielding countries to this high yielding economy. When such a thing happens you are certainly not going to be the only trader who will want to bank in on the carry-trade. This means the price of that currency pair will be pushed up ensuring capital appreciation for you. But the exact opposite effect takes place when the central bank cuts the interest rates. 

 Some times the central bank of a country may interfere into the exchange market to stop the rise or fall in the value of their currency. If a previously low yielding currency is strengthened for whatever reasons it may equate to losses for the trader involved in carry-trade. A low Volatility and risk seeking environment presents a good time for carry-trades because most of the big market players are after the yields and not necessarily the capital appreciation which is just a bonus and they won’t mind even if the currency does not move at all as it stays steady and doesn’t fall.