Carry trade is a type of forex trading whereby traders look to profit by taking advantage of interest rate differentials between countries. It is important to note that while popular, it can, however, be risky.
This strategy works because currencies bought and held overnight will pay a trader the interbank interest rate (of the country of which the currency was bought). A trader executing carry trade “borrows from” a low interest rate currency to fund the purchase of a currency that provides a higher rate.
A trader using this strategy wants to profit from the difference between the rates, which can be substantial depending on the amount of leverage used.
Carry trade is one of the most popular trading strategies in the forex market, but this trading style can be risky; these trades are often highly leveraged and can be overcrowded.
Common trading pairs include Australian dollar/Japanese yen and New Zealand dollar/Japanese yen because the interest rate spreads of these currency pairs are very high.
If you’re interested in the maths, the daily interest from a carry trade can be calculated as follows: Daily interest = [IR (long currency) – IR (short currency)]/ 365 x notional value.