Currency carry trading is used a lot, but many traders are not aware about it. It is a strategy which is used by financial institutes and major banks which have huge impact on the values of currencies worldwide. It is a much influential strategy which any traders must seek close attention to understand how such type of trading can affect their own trading.
Currency carry trading could be made when there is a variation between interest rates of 2 different countries. This technique uses the variation for extracting the gain with some risk. It is not usually done by the private traders since it needs much leverage for getting profit and is really worth risk involved. The financial institutes handle such type of leverage in an easy manner.
Let’s consider a simple example. The interest rate of US is 0.25 percent and Israel’s interest rate is 1.25 percent. There is some variation of one percent between rates of the 2 countries. These institutes take a loan in terms of US dollars with less interest rate and then purchase the assets or bonds which are quoted in terms of Israeli Shekels which is the NIS currency. The assets and bonds shall now definitely return higher values than the loan cost, which provide a small amount of profit. It is the place where leverage is used. Though the profit is actually small in terms of percentage, when we compound it through high leverage, we can get very huge profit. It depends on the amount we could invest in it.
There are also some trading expenses which usually takes some profit but it can be substantial. There is also certain risk with this type of trading since the currency value could change at any point of time. The currency carry trades is considered to be low risk investment. There is a major impact on all the traders in US with the change of funds from a currency to other and there are lot of differences n it. In example mentioned above, NIS is purchased and USD is sold and by changing demand and supply of the currency pair as well as changing its value.
This is the thing which many forex traders forget to consider, the difference in the interest rate can cost many carry trades to happen. It could be profitable for riding the coattails of the trades and could benefit from the prices of currency which cause the changes.
