Carry Trade Definition – A Carry Trade is a strategy in which an investor sells a certain currency, the funding currency, with a relatively low interest rate and uses the funds to purchase a different currency, the carry currency, yielding a higher interest rate. A trader using this strategy attempts to capture the difference between the rates, commonly called the “carry”. The “carry” gain can often be significant, depending on the amount of leverage used by the forex trader. The U.S. Dollar and the Japanese Yen have often been the funding currency of choice due to prevailing low interest rates set by their respective central banks. For the past few years, the carry currency or investment security of choice has been in Australia, New Zealand, and even in developing world countries like India. The trade is long-term in nature and was primarily the province of large global banks and financial institutions. However, forex brokers now support the strategy and will deposit the daily “positive carry” in your account. Methods range from buying spot, using options, or opening a simple carry account with your broker. The downside risk in a carry trade revolves around the uncertainty of exchange rates. If the funding currency strengthens for any reason, a forex trader may have to unwind his carry trade position unless the position is hedged appropriately. The global size of carry trade volume at a point of time is circumspect, but estimates reach $1-$2 trillion. A great deal of the turbulence witnessed during the Greek debt crisis was attributed to carry trade “overhang” being unwound.
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.