The carry trade is one of the simplest trading strategies in Forex and is among the most profitable, it is however not with significant risk. The carry trade involves taking advantage of the interest rate differences between currencies by selling a currency with a low interest rate in favour of another currency with a higher interest rate. For example, suppose the interest rate on the Great British Pound was 4.75% whilst the Japanese Yen only yielded 0.25%. Since interest rates are effectively the amount of money you are paid for owning a currency, the 4.5% difference between the pair's interest rates could be taken advantage of. In Forex we could take advantage of this by selling the Yen in favour of the Pound, i.e. going long on the GBP/JPY pair - most brokers pay you for holding a higher yielding currency against a lower yielding one.
The Carry Trade Risks,
Due to the high leverage that's often used in carry trades, the strategy is often described as 'picking up the nickels in front of a steam roller'. In the GBP/JPY example that I used above, holding the pair for one year would yield a 4.5% return minus the costs of trading, assuming that the interest rate difference between the pair remained the same and the exchange rate remained constant. Of course the exchange rate is highly unlikely to remain exactly the same, and an annual return of 4.5% probably isn't nearly sufficient for most trades. The temptation is therefore to use excessive leverage. With a leverage of 10:1 our example would have yielded a 45% return; however using such excessive leverage would mean that if the British Pound were to have fallen by 10% or more against the value of the Japanese Yen at the level it was at on the day the trade was taken then the entire trading account would have been lost due to the excessive leverage. The obvious solution would therefore be to use less leverage and only trade when the trend is moving in the direction of your trade. If done properly, the carry trade can be a very profitable Forex strategy. For more info, here's a link to a guy trying to turn a small deposit of $69.10 into interest payments of $1000 per month over the next ten years. If you're interested in using the carry trade then I'd recommend checking his site out and following his progress.
