Carry Trade

The use of one financial asset (such as the US$) to fund the purchase of another financial instrument is known as a carry trade. Your profit comes from the difference in interest rates. There are many ways to earn money when it comes to forex trading, but this is one that doesn’t require you to buy low and sell high all the time.

When investors are willing to take a chance, carry trades are an excellent option. Even if current economic conditions are not ideal, the future prospects must be bright. If a country’s economic outlook is bleak, no one will be willing to accept the risk of investing.

How does Currency Carry Trading Work

In the foreign exchange market, currency pairings are traded, for example the USD/CHF. In this situation, you are buying the greenback and selling the franc simultaneously. In forex trading, you pay interest on the selling position and receive interest on the buying position.

You can make money on the interest rate difference by purchasing high-yielding currency and financing it with low-yielding currency in a carry trade as long as there is no fluctuation in their relative exchange rates. Currency pairings with high-interest rate spreads such as AUD/JPY, NZD/JPY, and NZD/CHF are typically chosen for a carry trading strategy.

For a trade to be profitable, the interest rate differential must be more than the potential weakening of the chosen currencies throughout the transaction. When the global economy is doing well, a carry trade is more likely to be profitable. While a carry trade strategy might be risky in the short term, it can be highly beneficial in the long term.

Who makes these trades?

While one banking system may maintain or reduce interest rates, another may increase or decrease them. So, utilising a bin that contains only the top and bottom three currency pairings exposes only a part of the whole portfolio. As long as a basket of currencies is accessible, a currency carry trade’s losses are restricted regardless of the currency pair’s liquidation. This is the preferred method of trading foreign currency carry for investment banks and mutual funds. Due to the enormous sums of money sometimes necessary for basket transactions, this strategy may be perilous for individuals. So small batch sizes are frequently employed. On the other hand, a basket needs a significant movement in portfolio allocations in response to changes in the interest rate curve and the national bank’s objectives.

Pros and cons of carry trading

Carrying a position, like any other trading strategy, has a degree of risk. Economic and political factors can affect interest rates in different currencies. Maintaining a close watch on your gains and limiting your losses is essential in any form of trading.

Positive interest rates for currencies have a number of advantages. To begin with, you earn money via trading and interest.

The use of leverage can also considerably boost your earnings in forex trading (and losses). Carry trading is a flexible strategy for reducing downside risk. Trading for an extended period of time allows dealers to benefit from interest rate differentials.

You can also make money by learning how to carry trade and using it in your trading strategy.

Risks of carry trades

  • In the event that interest rates move in the wrong direction, your carry trade transaction might be in danger, and it is possible for a trend to shift suddenly. It is a wholesale unwinding of bets when the gap between two currencies is narrowed to a very low level.
  • About a decade ago, this wasn’t for USD/JPY. The bullish trend on the pair and the favorable rate differential had everything working for it until the subprime crisis hit.
  • Carry trading operations became less lucrative once the Federal Reserve decreased its interest rates. The USD/JPY exchange rate fell from 124 to 98 points in just over a year. Then carry trade operations grew less profitable as interest rates fell, making them less attractive to investors. A large number of hedge funds later
  • Carry trades are long-term investments that need careful money management and pips are the currency pair’s unit of measurement. When you have too much leverage, even the smallest of turns can be deadly. Also, risking too much capital on a single investment is not prudent money management.
  • Carry trades are not possible with a small amount.
  • When it comes to currency pair trends, there are several factors that might shift the direction of that pair’s price. Changing one of the components is all it takes to reverse the trend. For a long-term strategy, the carry trade is not beneficial if the trend shifts. Due to this, it is imperative that you pay attention to your entry point.

Frequently Asked Questions

When the cost of holding an investment exceeds the income received from it, we say that it has a negative carry.

The carrying value of a bond is the difference between the bond’s face value and any unamortised premiums or discounts. The carrying amount or book value of the bond is another term for the carrying value.

Positive carry occurs when a trader takes out a loan and invests the proceeds. Traders profit from the difference between loan interest and investment return interest, which was paid by the lender.

Holding an investment and earning a return on it is called “carry,” whereas the expense of holding an investment is called “cost of holding”.

Technically, the total return is calculated as follows:  (1+IDR rate)*(1+FX return) – USD rate = (1+10%)*(1+3%) – 2% = 11%]. If the spot FX rate does not change, the Carry Component (decided by the interest rate on IDR and USD deposits) is what you get.

In order to protect yourself against the risk of a carry trade, an investor might purchase options. Buying a call option reduces the carry trade losses if the foreign currency unexpectedly depreciates when an investor goes long on the currency.

Incur trades carry a high degree of risk due to the volatility of currency rates. The trader is in danger of losing money if the US dollar falls in value against the Japanese yen. It is likely that the actual losses are significantly bigger because carry trades are frequently leveraged transactions.

    Read the Latest Market Journal

    Unlocking Stock Market Potential with AI

    Published on May 24, 2024 29 

    Introduction of AI In the world we live in today, artificial intelligence (AI) is almost...

    Financial Sectors Thriving: Top Traded Counters in April 2024

    Published on May 21, 2024 76 

    At a glance: The Federal Reserve (Fed) held interest rates steady at 5.25% to 5.5%...

    One Dollar at a Time: The Potential of Fractional Shares

    Published on May 20, 2024 72 

    Table of contents 1. Introduction 2. Dollar-Cost Averaging 3. Popularity of Dollar-Cost Averaging 4. Small...

    Unit Trusts vs Exchange Traded Funds (ETFs) – Which is better for your portfolio?

    Published on May 20, 2024 74 

    Imagine you are dining at a nice restaurant, feeling overwhelmed by the variety of seemingly...

    Weekly Updates 20/5/24 – 24/5/24

    Published on May 20, 2024 20 

    This weekly update is designed to help you stay informed and relate economic and company...

    What is CFD? With 2 Practical Examples

    Published on May 15, 2024 105 

    In this article, you will learn what CFD (Contract for Difference) is, the costs and...

    What is ESG investing, and why is it important?

    Published on May 15, 2024 105 

    Over the last five years, Environmental, Social, and Governance (ESG) investing has evolved from being...

    What are fixed-income funds?

    Published on May 15, 2024 60 

    In the diverse world of unit trusts, various funds employ distinct investment strategies aligned with...

    Contact us to Open an Account

    Need Assistance? Share your Details and we’ll get back to you

    IMPORTANT INFORMATION

    This material is provided by Phillip Capital Management (S) Ltd (“PCM”) for general information only and does not constitute a recommendation, an offer to sell, or a solicitation of any offer to invest in any of the exchange-traded fund (“ETF”) or the unit trust (“Products”) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. You should read the Prospectus and the accompanying Product Highlights Sheet (“PHS”) for key features, key risks and other important information of the Products and obtain advice from a financial adviser (“FA“) pursuant to a separate engagement before making a commitment to invest in the Products. In the event that you choose not to obtain advice from a FA, you should assess whether the Products are suitable for you before proceeding to invest. A copy of the Prospectus and PHS are available from PCM, any of its Participating Dealers (“PDs“) for the ETF, or any of its authorised distributors for the unit trust managed by PCM.  

    An ETF is not like a typical unit trust as the units of the ETF (the “Units“) are to be listed and traded like any share on the Singapore Exchange Securities Trading Limited (“SGX-ST”). Listing on the SGX-ST does not guarantee a liquid market for the Units which may be traded at prices above or below its NAV or may be suspended or delisted. Investors may buy or sell the Units on SGX-ST when it is listed. Investors cannot create or redeem Units directly with PCM and have no rights to request PCM to redeem or purchase their Units. Creation and redemption of Units are through PDs if investors are clients of the PDs, who have no obligation to agree to create or redeem Units on behalf of any investor and may impose terms and conditions in connection with such creation or redemption orders. Please refer to the Prospectus of the ETF for more details.  

    Investments are subject to investment risks including the possible loss of the principal amount invested. The purchase of a unit in a fund is not the same as placing your money on deposit with a bank or deposit-taking company. There is no guarantee as to the amount of capital invested or return received. The value of the units and the income accruing to the units may fall or rise. Past performance is not necessarily indicative of the future or likely performance of the Products. There can be no assurance that investment objectives will be achieved.  

    Where applicable, fund(s) may invest in financial derivatives and/or participate in securities lending and repurchase transactions for the purpose of hedging and/or efficient portfolio management, subject to the relevant regulatory requirements. PCM reserves the discretion to determine if currency exposure should be hedged actively, passively or not at all, in the best interest of the Products.  

    The regular dividend distributions, out of either income and/or capital, are not guaranteed and subject to PCM’s discretion. Past payout yields and payments do not represent future payout yields and payments. Such dividend distributions will reduce the available capital for reinvestment and may result in an immediate decrease in the net asset value (“NAV”) of the Products. Please refer to <www.phillipfunds.com> for more information in relation to the dividend distributions.  

    The information provided herein may be obtained or compiled from public and/or third party sources that PCM has no reason to believe are unreliable. Any opinion or view herein is an expression of belief of the individual author or the indicated source (as applicable) only. PCM makes no representation or warranty that such information is accurate, complete, verified or should be relied upon as such. The information does not constitute, and should not be used as a substitute for tax, legal or investment advice.  

    The information herein are not for any person in any jurisdiction or country where such distribution or availability for use would contravene any applicable law or regulation or would subject PCM to any registration or licensing requirement in such jurisdiction or country. The Products is not offered to U.S. Persons. PhillipCapital Group of Companies, including PCM, their affiliates and/or their officers, directors and/or employees may own or have positions in the Products. Any member of the PhillipCapital Group of Companies may have acted upon or used the information, analyses and opinions herein before they have been published. 

    This advertisement has not been reviewed by the Monetary Authority of Singapore.  

     

    Phillip Capital Management (S) Ltd (Co. Reg. No. 199905233W)  
    250 North Bridge Road #06-00, Raffles City Tower ,Singapore 179101 
    Tel: (65) 6230 8133 Fax: (65) 65383066 www.phillipfunds.com