Carry Trade: the strategy in the foreign exchange market29 / March / 2020
Carry Trade: the strategy in the foreign exchange market
Carry is a borrowing or sale of a financial instrument with a low discount rate and then using it to buy an instrument with a high interest rate.
In other words, you buy or rent an asset that does not have a high percentage and at the same time you hand over an asset with a higher percentage. Thus, you earn from the difference. As an example, I can give the following situation:
We have information that government bonds now give 8% per annum. We are looking for a bank that will give us money at 5% per annum. Our net profit is three percent. If you took $ 100,000, then $ 3,000 of net profit.
Yes, there is not much interest, it’s not to build Fibonacci levels or draw moving averages, and the profit is not very large, 3% per year in total. But as soon as it is worth remembering that there is an interbank currency spot market, on which leverage is practiced and you can take profits every day, it becomes somehow more pleasant. We take x20 leverage and earn 3% with 3%, and this is $ 60,000 a year.
Let’s now analyze in more detail such concepts as overnight / rollover / swap, who carries out the Kerry trade and what risks are inherent, where would it be without them.
Rollover in the foreign exchange market
Many think I already understand that in the forex market currency pairs are traded. If you see an increase on the eurusd chart, you click "buy", so you buy euros for a dollar, that is, you sell a dollar. Carrying out this trade, you pay interest on the sold foreign exchange position, and collect on the purchased foreign exchange position.
Carry trade shows itself perfectly precisely because these percentages are paid every day. What kind of interest are these? In the currency spot market, in theory, all transactions are closed at the end of the trading session and open the next day. This is not familiar to many, since they hold transactions for several days. In fact, this is so, just traders do not notice it. For transferring a position (roll-over), the trader pays a percentage depending on the difference in discount rates of two currencies per night (overnight).
Rollover is a percentage of the transaction, which is obtained based on the transition of an open position to the next trading session.
Rollover can be both positive and negative. That is, you can lose money for transferring a transaction and earn money. Each currency has its own interbank overnight discount rate, given that two currencies participate in the trade, two discount rates are taken. This is where the money comes from. If the purchased currency has a discount rate higher than the sold one, then you get the difference. If on the contrary, then you have to pay rollover.
The concept of rollover is extremely rare, I think you will immediately understand what it is about, if you see the word "swap", it is used by many brokers.
And the popularity of Carry trading gave the presence of leverage, which makes it possible to earn normal money. With the help of margin trading, having not at all a large balance can earn a lot.
Carry trade. Profit or loss?
In principle, Carry trade is considered quite a profitable business, but also highly risky. You must clearly understand that the economic situation of countries can change, and with it the interest rate, everything rests on a fundamental analysis. If the economic links work well, the Central Bank can increase the interest rate, for a Kerry trader this is a great addition, since the percentage of earnings will be even higher.
But if at the moment the country does not have a good macroeconomics, then buying its currency does not particularly justify the risks. The interest rate may decline at any time, and your loss will increase. If you cannot correctly assess the risks, then Kerry trading can fatally end for you.
Carry trade for forex trading is a perfect tool. As I said here, forex trading is ideal for trend trading, and carry trade is for forex trading. Using a fairly simple principle: bought a tool with a low interest rate, sold with a high one, you can really earn a lot. Kerry trade is a long-term professional trade, it is not suitable for retail traders, because deposits are too small. But if we take multibillion-dollar funds as an example, then this is one of the main types of earnings.