Carry trade
Carry trade strategy is one of the most popular strategies among traders who follow fundamental forex trading strategies. It involves buying currency with a high interest rate and selling a low interest rate. As a result you pay rollover interest on the low interest currency while earning interest on the high interest currency. In short the interest rate differential delivers you the profit. One currency pair that has been riding this trend is AUD/JPY.
Bank of Japan has maintained a near zero interest rate policy, while Reserve Bank of Australia has had one of the highest interest rates among major currencies in the high 4% range. Many savvy fundamental traders have followed on the carry trading strategy on AUD/JPY pair which is one of the factors contributing to the uptrend. Following the pair from early 2009 to early 2010 has shown gains over 3000 pips.
Coupled with the interest rate differential profit, traders who jumped on this trend would have generated handsome profits.
Risks in Carry Trade Strategy
As with any other strategy you should assess the risk potential. It is recommended to sue carry trade on: 1) currencies that do not fluctuate much or 2) on currencies where in addition to the positive interest differential you are also buying the currency with better gain prospects. Many a times, going after a interest based profit you end up losing on the currency pair movement.
Steps:
1. Pick a currency pair with high interest rate differential (AUD/JPY, NZD/JPY are good examples)
2. Buy the currency with the higher interest rate while selling the other one. Also ensure the respective reserve bank meetings are not any time soon to announce interest rate changes
3. If you are looking to hold for the long-term, ensure a moderate position size to weather short and medium term fluctuations
4. Set a stop-loss if you are risk averse, if not don't place one as the pair is more likely to bounce back into the trend (one of the few forex trading strategies, where stop-loss isn't recommended)
5. Wait till you have reached the point where you expect major economic activities change in the countries or any major global turn of events to close the position
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