A carry trade involves borrowing an asset that pays a lower interest rate than the forex trading account and purchasing an asset that pays a higher interest rate.
Carry Trade is a term used in Foreign Exchange (forex) trading to describe the purchase of an asset whose interest rate or yield is expected to outperform that of another.
The term is most typically used concerning currencies; hence, forex carry trades, where traders borrow cheap currency and buy expensive ones.
The objective of this strategy is to capture the difference between the two rates and generate an attractive source of profits.
The general principle behind the strategy rests on the fact that all currencies are liquid relative to each other.
Therefore, each pair can be exchanged for one another at any time without affecting their price.
Thus if two currencies possess an interest rate differential more excellent than the cost of carrying out a transaction between them, it offers scope for risk-free profit (check out Interest Rate Parity).
A rise in interest rates causes capital gains on long positions on the currency with the higher interest rate and tends to cause losses on short positions of this currency.
There are two types of currencies in British forex trading: high yield and low yield.
High-yield currencies include the New Zealand dollar (NZD), Australian dollar (AUD), Canadian dollar (CAD) and the United States dollar (USD).
Low yields pertain to currencies such as the Japanese yen (JPY) and Euro (EUR). In current market conditions, holding either one of these currency pairs is considered a carry trade.
To open up the necessary positions, one must borrow funds in the low-yield currency and purchase assets in high-yield currencies (British forex trading).
One popular choice is to purchase the USD/JPY because of the higher interest rate on Japanese yen accounts.
Let’s compare holding Japanese yen vs holding U.S. dollars for an extended period:
- JPY offers a 0.1 per cent interest rate, while USD has a 0.2 per cent interest rate.
- Japanese government bonds (JGBs) offer a 1.0 per cent yield compared to the U.S 2 year bond offering at 1.4%.
As seen in the above examples, holding the Japanese yen and purchasing U.S dollar assets is more beneficial than holding U.S dollars and purchasing the Japanese Yen.
However, there is also the risk of exchange rates fluctuating and then making these profits disappear or even leading them into losses if they are not careful when carrying out these trades.
In addition, as with all investments, the carry trade is risky and subject to certain specifications such as limited investment timeframes and stringent account conditions.
Most forex trading brokers offer accounts with a minimum deposit of only $50 or even nothing at all. It allows for brokerage fees to be spread out over a long period. It makes commissions minimal compared to other types of investments.
They would be required to invest a considerable amount to make a significant return on their investment, which is not the case with carrying trades (in British forex trading).
One should also remember that these respective currencies are traded at different times throughout the day due to each country’s time zone differences, so there needs to be enough capital for day trading.
The carry trade strategy is a low risk/high reward strategy that should be researched and carefully analysed before applying to any British forex trading accounts.
If you have an interest in learning more about how to enter the market with little capital or gain a better understanding of this type of investment, please feel free to contact us for further information at your convenience.
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