In general, the forex trading strategy know as the "Carry Trade" refers to an increasingly widespread forex trading strategy that is usually implemented over longer term time frames and involves taking advantage of the interest rate differential prevailing between two currencies.

Furthermore, using such an interest rate strategy in your forex trading will make the most sense if you use a forex broker that provides particularly attractive rates on rollovers for the currency pair you are most interested in putting on a carry trade with.

Profiting From Interest Rate Differentials

Since carry traders basically look to capture the interest rate differential between two currencies, as well as hopefully some additional appreciation from favorable exchange rate movements, they need to choose their pairs wisely based on two primary criteria.

The first is the magnitude of the interest rate differential itself. The absolute value of this differential can be readily computed by subtracting the higher interest rate from the lower interest rate for each currency involved. The interest rates used will be those prevailing for Interbank deposit rates for the time period during which the carry trade will be kept on for.

The second consideration is the likelihood of appreciation of one currency versus the other. Since carry trades tend to be longer-term positions, a combination of fundamental and technical analysis is often used to arrive at this forecast.

For the best carry trade scenario, you will want to choose the highest interest rate currency that stands the best chance of appreciation against the lowest interest rate currency according to your forecast for the future exchange rate over your time frame of interest.

Carry Trade Profits and Risks

Not only do carry traders hope to capture the resulting favorable interest rate differential or "positive carry" as it is often called, but they usually also plan on benefitting from interest rate compounding effects, as well as from any currency appreciation seen.

The sum of these factors at the time the trade is closed out will determine their profit or loss on the carry trade.

In terms of risk management, the interest rate differential provides something of an initial protective buffer against losses that might accrue due to adverse exchange rate movements. Nevertheless, stop losses can be placed at strategic points that stand a reduced chance of being executed as an additional form of risk management.

Additional Profits or Costs of Rollovers

Rollovers of currency positions tend to be executed automatically by most online forex brokers if the position is held over the time of 5 PM Eastern Standard Time.

An automatic rollover means that the broker will automatically close out your existing forex position for value spot and roll it forward for value one additional business day in the future. Since rollover rates can vary substantially among forex brokers, make sure you choose a broker with competitive rollover rates if you intend to put on carry trades.

Generally, when forex traders have their currency positions rolled, they will get paid pips to do so if they are holding the higher interest rate currency. On the other hand, if they are holding the lower interest rate currency, they will pay pips away when their position is rolled over.

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.