Carry Trade

Carry trading is defined as a trading strategy where investors can borrow at low interest rates, simultaneously investing in an asset that provides a higher rate of return.

This commonly includes currencies, or forex trading, though can extend to other assets such as commodities and others as well.

This type of strategy is popular given investors can profit from differentials in interest rates.

For example, if you are paying a low interest rate on the financial instrument you borrowed/sold, you are collecting higher interest on the financial instrument you purchased.

Carry Trades in Forex

Carry trading in forex represents an uncovered interest arbitrage.

A risk in carry trading is that forex rates may change in such a way that investors would have to pay back more expensive currency with less valuable currency.

In theory, carry trades should not yield a predictable profit due to the difference in interest rates between two countries should equal the rate at which investors expect the low-interest-rate currency to rise against the high-interest-rate one.

However, carry trades weaken the currency that is borrowed, because investors sell the borrowed money by converting it to other currencies.

Common carry trades in forex involve the purchase of Antipodean currencies such as the New Zealand dollar (NZD) or Australian dollar (AUD) against other major currencies such as the Japanese yen.

Forex traders can profit from the difference in the interest rates between two countries if the exchange rate between the currencies is stable.

This can seemingly be achieved when leverage is factored in, given they can profit several times the interest rate difference, depending on what leverage is used.