If you’ve been exploring the world of forex trading online, you might have come across the term “carry trading.” It sounds fancy, but don’t worry—it’s a straightforward concept that even beginners can understand and, potentially, benefit from. In this article, we’ll break down carry trading in simple terms, explain how it works, and highlight the pros and cons so you can decide if it’s right for you.
What is Carry Trading?
At its core, carry trading is a strategy that allows you to profit from interest rate differences between two currencies. When you trade forex, you’re essentially buying one currency while selling another. These currency pairs come with their interest rates, set by the central banks of the countries involved. Carry trading takes advantage of these interest rate differentials.
Here’s the basic idea: you borrow money in a currency with a low interest rate (like the Japanese yen or Swiss franc) and use it to buy a currency with a higher interest rate (like the Australian dollar or New Zealand dollar). As long as you hold the position, you earn the interest rate difference between the two currencies. This interest is called the “carry.”
For example, let’s say the interest rate in Australia is 4%, while Japan’s interest rate is 0.1%. If you buy AUD/JPY (Australian dollar/Japanese yen), you’re essentially earning the 4% Australian rate while paying the 0.1% Japanese rate. That nets you a 3.9% interest profit and any potential gains from currency price movements.
How Does Carry Trading Work?
Choose a Currency Pair: Look for a currency pair with a significant interest rate differential. Common pairs for carry trading include AUD/JPY and NZD/JPY.
Check the Interest Rates: Research the interest rates set by the central banks of the currencies you’re trading. You can find this information easily when trading forex online through your broker’s platform or a quick Google search.
Open a Position: Buy the currency with the higher interest rate while selling the currency with the lower interest rate.
Earn the Carry: As long as you hold the position overnight, you’ll earn the interest rate difference. This is often credited to your trading account daily.
3 Main Benefits of Carry Trading
Steady Income: The main appeal of carry trading is the potential for a steady income stream from the interest rate differential. Even if the currency pair doesn’t move much in price, you can still earn from the carry.
Long-Term Potential: Carry trades often work best as long-term strategies. The longer you hold your position, the more interest you can earn.
Double Opportunity: In addition to earning interest, you can also profit from favourable currency price movements. For example, if the Australian dollar strengthens against the Japanese yen while you’re holding a long AUD/JPY position, you’ll gain even more.
Simplicity: Compared to other forex trading strategies, carry trading doesn’t require constant monitoring of the markets. Once you’ve set up your trade, you can sit back and let the interest payments roll in (as long as the market behaves).
4 Risks of Carry Trading
Exchange Rate Volatility: While you’re earning interest, the value of the currency pair could move against you. If the Australian dollar weakens significantly against the Japanese yen, for example, you could lose more on the exchange rate than you earn from the carry.
Leverage Risk: Carry trades are often leveraged to amplify returns, but leverage can also magnify losses. Be cautious and only use leverage if you fully understand the risks.
Interest Rate Changes: Central banks can adjust interest rates at any time. If the interest rate in the higher-yielding currency drops or the lower-yielding currency’s rate rises, the carry trade becomes less profitable.
Overnight Holding Costs: While you earn interest from the carry, you might also incur fees from your broker for holding positions overnight. Make sure these fees don’t eat into your profits.
5 Awesome Tips for Beginners
Start Small: If you’re new to carry trading, begin with a small position to minimise risk while you learn how it works.
Use a Demo Account: Practice carrying trading in a demo account before using real money. This will help you get a feel for how interest payments and price movements affect your trades.
Research and Stay Updated: Keep an eye on global economic events and central bank policies. Interest rates can change, and so can the profitability of your carry trades.
Diversify: One trick beginner should know is to not put all your eggs in one basket. What you can do is, spread your trades across multiple currency pairs to help reduce risk when trading.
Choose the Right Broker: When trading forex online, work with a broker that offers competitive spreads, low overnight fees, and reliable customer support.
Is Carry Trading Right for You?
Carry trading can be a great way to earn passive income while trading forex online, but it’s not without its challenges. It’s best suited for traders who are patient and willing to hold positions for extended periods. If you prefer quick, high-energy trades, this strategy might not align with your style.
Ultimately, success in carry trading comes down to understanding the market, staying informed, and managing your risks. With practice and a bit of patience, carry trading could become a valuable addition to your forex trading toolkit. So this 2025, why not give it a try? Who knows this might work for you. Happy trading!
