Carry trade is quite a popular move among major players, that is banks, hedge funds, et al, especially when policy divergence among leading central banks widen as it is now. However, is carry trade is actually possible in small-scale forex trading that we retail forex traders do?
Carry trade refers to the act of selling a currency with low interest and buying another currency with higher interest at the same time in order to take advantage of the difference of interest rates.
It is quite a popular move among major players, that is banks, hedge funds, et al, especially when policy divergence among leading central banks widen as it is now. However, is carry trade actually possible in small-scale forex trading that we retail forex traders do?
Yes, carry trade is possible, unless your broker doesn't allow you to do so. What does it mean?
The Theory Vs Cruel Reality
Theoretically, carry trade is possible.
Let's say NZD/USD. At 3.25%, New Zealand's OCR counted as the highest rate among leading currencies now, while US the Fed's 1% rate is closer to zero.
So if we buy NZD/USD, we actually sell funds with 1% interest in order to get to funds with 3.25% interest. Considering forex spot market apply swap for overnight trades, you'll get quite a substantial amount of profit from daily interest by simply letting it sit.
Remember that forex brokers apply swap rates as well, so if they apply swap in accordance with each country's central bank benchmark rates, traders certainly will be able to take advantage by doing carry trades.
THAT is IF your broker applies swap in accordance with each country's central bank benchmark rates.
Which is actually unlikely.
Swap rates charged by forex brokers are drawn from interbank rates, which are more often than not, at different rates than the central bank's benchmark.
Plus, terms and conditions on several brokers clearly spelled that they will hand you a negative rates on overnight trades (add that with: no matter what the rate difference between currencies).
Or alternatively, they hand you the negative rates but pocket the positive rates.
So, yeah, if you want to carry trade, confirm it with your broker first to ensure that it is possible with them. It is not something that is commonly advertised for all to see, so you might have to ask plainly.
Price Changes, Not Stands Still
Let's say your broker is so good-natured that they will hand you positive rates for rollovers, so you trade the NZD/USD and leave it for a year.
Considering the disparity of interest rates between currencies as well as the leverage that surely boosts the power of your funds, a year from now you should have gained a lot even without doing anything.
But you see, there is no guarantee that NZD/USD pair price will end up at exactly the same price then as it is now. Price changes all the time in the forex market, and no one can predict with 100% accuracy.
- If price changes mean that NZD/USD will go up even further, then that is very good news for you (congratulations!).
- But say, NZD/USD drops far lower than the level at which you opened your position. The interest you've gained might mean nothing then.
What's more, interest rates might change too. Consider now when some central banks are considering to hike their rates and some others are cutting it lower without prior warning, in addition to other unexpected major policy changes.
On such occasions, trading platforms and liquidity providers in the market might have to cut all opened trades and or significantly affect your floating trades, thus making you unable to harvest the advantage from carry trades that you've been hoping for and possibly get massive loss instead.
What You Can Do
Disappointed? Don't be. Chances are, you will be able to take advantage of carry trade by riding on the back of the trend or by trading with a broker that allows positive swaps. Here's how:
1. Follow Market Sentiment
You see, those that actually have the power to move the market are big players; government, banks, etc. When they play in the market, they play big with different rules that enable them to triple or quadruple their profit through carry trade.
So, let them do the carry trade, and just sit back enjoying the ride. Analysts will tell you when carry trade abounds, and that is when you could take advantage of it if you are someone who notes fundamental changes in forex trading.
2. Try Exotics
In case your broker will hand you positive swaps, then yes, carry trade is possible for you. Still, you have to carefully pick only currencies with real wide interest gaps.
Among major currencies now, it means AUD/JPY and NZD/JPY. However, there are no wider gaps than the Japanese Yen (0% interest) with emerging currencies, such as Turkish Lira (TRY) with 8.25% interest.
3. Short-Term Only
Whether you are taking advantage by following market sentiments or actual carry trade, you are going to sell the currency with lower rates and buy the currency with a bigger one at the same pair.
But note that the trend will not go on for long. In fact, samples of charts among pairs with big rate gaps often do not show a significant bullish trend in the long term, with a few exceptions.
Therefore, you should take notice of market sentiment to know the proper levels when to enter and exit the pairs.