Recently, the breakdown of the “yen carry trade” has graced the front page of major financial newspapers and business magazines. But what is a “carry trade” and how does it affect the forex? More importantly, how can you, as an individual investor, profit from carry trades? This article endeavors to provide the answers.
What is a Carry Trade?
First, it is important to remember that each forex trade is actually the simultaneous buying of one currency and selling of another. As a result, you end up receiving interest on the currency you purchase, and paying interest on the currency you sell. A carry trade takes advantage of this by seeking out high-yielding currencies to purchase while simultaneously selling low-yielding currencies — allowing the trader to pocket the difference in interest rates.
For example, if you had purchased U.S. dollars with Japanese yen a few years ago, you would have received around 4% interest on your U.S. dollars, while paying out less than 1% on your yen. This would be a net profit of 3%, which, given the huge leverage of forex trades, could add up to a lot! Alternatively, if you did the trade the...
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