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Doing the Foreign Exchange Carry Trade

Discussion in 'Forex Discussions' started by painofhell, Nov 2, 2015.

  1. painofhell

    painofhell Content Contributor

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    Foreign exchange trading is a great alternative way to invest and make money. It has it's caveats, but as long as you treat it with respect and not as a fly by night get rich scheme, it can serve you well.

    One of the easiest, or seemingly easiest ways to make money trading foreign exchange is to do a carry trade. A carry trade is a trade that pays interest into your account every day. When you hold trades for more than a day, your broker will add or deduct interest from your account depending on the trades you have open.

    In order to have a successful carry trade, you need to pick a high interest currency and trade it against a low interest one. Every day, your broker will deposit a small amount of money into your account depending on how large of a trade you are holding and which pair.

    So, you may wonder, what is the big win of this situation.

    Foreign exchange trading through a broker allows the use of leverage. Leverage allows you to make trades much larger than the actual money that is in your account. The interest that you get paid is based on that inflated trade size, not the amount of capital that you are using to open the trade. If your leverage were 5:1, it would take $200 to open a trade of $1000. You would receive interest on the $1000. Even at a few percent a year, that would be a phenomenal amount of interest paid on the $200.

    So, if it's that easy, why aren't there more millionaires exploiting this little loophole. Mainly because there are some side effects to doing carry trading. One big one is that you can't really use the full value of your account to open trades, it would be too dangerous to be that leveraged on a constant basis.

    The other thing is that carry trading is a "fair-weather" sort of sport. That is to say, that if things get uncertain in the global markets, hedge funds usually take their money out of these little interest machine trades and there is usually a blood bath. This doesn't really happen in big severity often, but the pairs that pay are usually the first to suffer when things get ugly.

    The other thing is that when these pairs move backward, they do with a large amount of force usually, at least in comparison to other currency pairs. This means, you have to be prepared to sit on losses sometimes and also you have to have room to absorb them. Carry trades are rather unpredictable due to their nature, you may get a knee jerk reaction on bad news, or if it's scary enough, you can see thousands of pips of distance made in hours.

    How to use carry trading to your advantage

    Carry trading still has it's place. It's not just an easy answer to trading altogether because of it's dangers, however, it's a good add on method for trading(see: Methods of Forex Trading). That is, something else you can do along side of your regular forex trading strategy. You could either add some trades in your regular account, or open an additional account and make some long term holders. The main thing is to keep in mind that these trades are risky, so you either need to setup disaster stops, or make your trades small enough that you can handle substantial hurt.

    The method that you choose is up to you. Everyone has their own risk tolerance. The main thing is that you keep a plan for what you want to do should things go unexpectedly wrong.
     
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