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Currency Trading Strategies -The Carry Trade

October 9, 2011 · 3 comments

in Forex Trading

Just bought that new printer? It’s so amazing it can also most do anything; you swear you could print money with it. Alas! It doesn’t. Well here is one of the numerous currency trading strategies that promises to make you money.

During the 90’s the Japanese economy experienced one of its worst financial crisis. To combat this, Japan adopted a policy for low interest rates. This means that any individual could borrow the Yen at low interest rates. The Bank of Japan has continued this policy only increasing their interest a few percentage points.

Carry Trade is one of those numerous currency trading strategies where an investor sells a currency with a low interest rate for example the Japanese Yen and buys a different currency having a higher interest rate (USD) making a profit in the difference of their interest rates.

Investments can be magnified by some traders who offer leverage. Investment and currency brokers offer their investors a trading leverage of 100:1. This means that for every $1,000 of investment, a $100,000 trade is possible.

 What to look out for

  • Currencies whose value has been on an upward trend

Look for stable currencies, the Euro and the GBP (British pound) are trading at higher prices and has maintained their strong positions comparative to the dollar. Profits are not only made through difference in currencies traded but also when a currency purchased also rises in value compared to its pair.

  • Find a currency pair with a high interest differential

Japanese interest’s rates have remained low and stable. Carry trade pairing is usually done with the Yen because of this. The US dollar is usually paired with the Yen because the USD has a relatively high interest rate, thus a higher rate differential essential for effective currency trading strategies.

How it works

This is how the Carry Trade currency trading strategy works:

  • Money is purchased or borrowed from a currency with a low interest rate, in this case the Japanese Yen
  • The money is then invested in another currency (USD) which has a higher interest rate.
  • The invested currency which has now been transformed to the USD is then loaned out. The higher interest rate allows the investor to rake in profits. A loan made with a $10,000 investment which for example has a 4.5% interest rate makes $450.

Possibilities for Long Term Investments

 No change in rate interest differential

The Japanese rate at the interest rates maintains its rate at 0.5% and the USD remains at 4.5%. The rate differential which was 4% at the beginning of the year assures the investor that the expected profit is assured.

 Currency paired appreciates in value

Rate differentials remain basically the same till the end of the year. A movement of a few percentage points in rate differentials. The Japanese Yen starts at .5% and end at .8% and the USD moves from 4.5% to 4.7%. The USD strengthens against the Yen, the dollar which is trading at $1 to 80 Yen at the year ends at $1 to 90 Yen. Profit is made not only by the rate differential but also by the strengthening of the invested currency.

 Rate differential goes to negative or drops

Currency trading strategies only gives us some ideas as to the probability of making profits. A scenario of the Japanese Yen hiking up its interest’s rates at 5% and the USD dollar dropping to 1% is highly unlikely but not entirely impossible. When this happens the rate differential which were +4 at the beginning may turn out to be a -4. Profits are made with positive rate differential thus losses are incurred.

Currency paired drops in value

Another scenario is when the currency investment drops in value compared to the paired currency. The USD may suddenly drop in value trading. The USD dollars weakens and trades lower to the Yen. The loss is made because when the USD is returned to the Yen, a loss is incurred.

 Overview

Like all business currency trading also presents risks. Currency trading strategies only provides us some ideas on how to make intelligent investment decisions. Factors such as changes in economic policies like increasing or decreasing interests rates are hard if not impossible to predict. Movements in currencies and the Foreign exchange market happen every second. Every trading decision changes in policies or economic outlook affect the market; currency trading strategies are based on past trading experiences and the most likely market trends. In the mean time, the Yen carry trade still remains as one of the best strategies for currency trading.

Written by Michael Scottsdale

Michael Scottsdale is a professional writer and currently works as a consultant for online businesses. When he’s not writing for Intermedia’s Office 365, he could be found blogging about simple tips on how people could take advantage of the internet’s numerous business opportunities.

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