Carry trade is one of the profitable strategies used in the foreign exchange market. It refers to a strategy in which a trader sells a currency having low interest rate and utilizing the proceeds to buy a different currency with high interest rate. A trader practicing carry trading aims to profit from the difference between the rates, as long as the position is in the interest positive direction. And, the profit may be considerable depending on the level of leverage taken into consideration.
As an example, if the British Pound (GBP) has a 6% interest rate and the United States dollar (USD) has a 3% interest rate, and if you enter a buy position on the GBP/USD, then you are making a carry trade that can be very profitable over time. For each day that you will be holding that trade, you will profit from the difference in the interest rates of the two currencies (3%), which can be a substantial amount depending on the amount of leverage you will be using.
Using carry trade as a strategy in the Forex market has several advantages. Some of which are substantial trading and interest gains and the opportunity of using leverage to maximize returns. When you earn profit from the difference between the interest rates of two currencies, the profit paid is based on the leveraged amount. For example, if you enter a trade for one mini lot (10,000 USD) and you set aside only $300 from your trading account for that transaction, you will get profit based on the leveraged amount ($10,000) and not $300.This can be very profitable when accumulated over an extended period of time.
The risk associated with carry trade is the possibility of exchange rates not remaining the same. Using the example above, the investor could experience massive losses if the trade does not go in the interest positive direction. In addition, carry trade positions are usually entered using high level of leverage; therefore, small fluctuations in the value of interest rates could lead to increased losses if proper risk management is not effectively carried out. If you enter a position using carry trade and the exchange rate does not move in your favor, then you risk losing some of your cash.
Like any other strategy in Forex trading, carry trading should be used in combination with other strategies such as technical analysis and fundamental analysis. Otherwise, carry trade positions can cause you a fortune in losses.