Information is not investment advice
It is a type of trading in which a trader sells a certain currency with a low interest rate and then uses it to purchase another currency that yields higher interest. The main goal of a carry trader is to capture the existing divergence in interest rates and earn substantial profits with help of leverage.
Assume you notice that interest rates in South Africa are 7%, while the current interest rates in the US are 1%. So, you expect to earn 6% difference between the two rates. For this to happen, you should borrow USD (the low-yielding currency, the issuer of which set a relatively low interest rate), and buy a higher-yielding currency, in our example it is South African Rand. You may increase the amounts of money you earned using leverage. For example, if you use a standard 10:1 leverage ratio you can earn a profit of 60%. But there is a big risk behind this – the unpredictability of exchange rates. If the ZAR was to drop against the USD, you would lose a great part of your return. Find out what is the carry trading strategy?
So, although carry trades look very attractive, they are quite risky especially in troublesome, uncertain times when investors tend to rush into low-yielding safe-havens neglecting risky financial assets, which offer higher returns.
Profits earned through the carry trade may not be a primary goal of the trader, they could be a good addition to the gains he/she earns on price fluctuations.
Example of a trader
Julian Robertson is one of the most famous carry traders the history knows. He used to trade USD/JPY. In the period between 1995 and 1998, this currency pair appreciated more than 66%, in part thanks to carry traders buying high-yielding currencies and selling the yen. The trader could make 15% profits on the interest rate differentials adding to 66% he gained on the surge in USD/JPY. Julian Robertson was trading USD/JPY with leverage and earned lots of money in that period, although after the 1998 sudden appreciation of the yen, he lost $2 billion.
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