Carry Trade

If you know anything about the art of currency trading you've probably heard of the 'carry trade,' which for much of the past five years or so has been synonymous with any mainstream discussion about forex. The strategy - where an investor generates income from the interest rate differential between two currencies - has been by far the most popular trade in recent times, with as much as 50 per cent of all trades involving the strategy.

How does the carry trade works?

Quite simply, investors borrow from a low yielding currency and invest in a high yielding one, and earn income from the interest rate differential between the two. The most obvious, and most commonly used, example over the past two to three years that brings this strategy into context involves the Japanese Yen and the New Zealand Dollar.

Of course, it's not as simple as all that, and in the real world valuations between two currencies (known as a currency pair) fluctuate according to supply and demand, and an overvalued currency can make a 'carry trade' less effective. Investors also need to keep a close eye on the interest rate movements of central banks, which ultimately provide the yield which makes the carry trade so attractive.

Considering its success in the past, the question is: why the significant drop in the number of carry trades being executed, and why now?

There is not an easy answer but the recession has something to do about it. That´s whay many investors had changed their strategy to momentum and fundamental trades to generate returns.

Remember in Forex is a good thing to have more than one strategy when you are trading, because you can divide your risk. The Forex market is risky and you need to protect yourself so you don´t loose money.

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Have a great day until next time!