David Waring

In our last lesson we continued our free forex trading course with a look at a specific example of how interest rates move the market. In today's lesson we are going to look at one of the more popular strategies employed by currency traders looking to take advantage of interest rate differentials, the carry trade.

As we learned about in our lessons on how rollover works in module two of this course, when holding a position past 5pm NY time traders earn interest when they are long the currency with the higher interest rate. Conversely, when traders are long the currency with the lower interest rate they pay interest when holding a position past 5pm NY time.

Like the US investor in the example from our last lesson who took his US Dollars and invested them in New Zealand Bonds to earn a higher return, currency traders can also take advantage of countries which offer higher interest rates. Luckily for us however taking advantage of interest rate differences between countries is generally much easier for currency traders who can do so with a simple click of the mouse.

To help demonstrate this lets look at the interest rates as set by the central banks for the main currencies which we are interested in. As you can see here and as we went over in our last lesson, rates as set by the Federal Reserve in the United States are currently at 2%, and rates as set by the Bank of New Zealand are currently at 8.25%.

Now lets bring up a screen shot of the simple dealing rates window of the FXCM platform and locate the New Zealand Dollar/US Dollar Currency pair. If we buy this currency pair, then we are long the New Zealand Dollar which is the higher yielding currency, and short the US Dollar which is the lower yielding currency. With this in mind we earn $10 per contract held past 5pm NY time as shown in the Roll B column of the simple dealing rates window. Conversely, if we sell this currency pair then we are short the higher yielding New Zealand Dollar and Long the lower yielding US Dollar, so we pay $15 dollars per contract held past 5pm NY Time, as shown in the roll s column of the window.

As you can see here, we can take advantage of the higher interest rates in New Zealand by buying New Zealand Dollars and Selling US Dollars with the click of the mouse, and without having to go through the trouble of figuring out how to buy New Zealand bonds as we would have had to in our last lesson.

Because of the simplicity of this strategy and the fact that in addition to the interest that one earns by being long the currency with the higher interest rate there is the opportunity for capital appreciation should the higher yielding currency move in one's favor, this is a hugely popular strategy. This is important to us as traders not only because it is a strategy that we may want to consider trading at some point, but also because a huge amount of capital flows in and out of currencies based on this strategy, making it a major market mover in both the long and short term time frames.

Lastly, it is important to us as traders to understand that when a trader is long the carry, meaning that he or she is long the currency pair with the higher interest rate, then that trader is normally trading with the wind at their back as they are getting paid every day they hold their position, regardless of what happens to the exchange rate. Conversely when a trader is short the carry, meaning that they are long the currency pair with the lower interest rate, then they are generally trading with the wind in their face as they are paying money every day, regardless of what happens with the exchange rate.

Thats our lesson for today, in our next lesson we will continue our discussion of the carry trade with a look at the role that leverage plays in the strategy, as well as some other factors that need to be considered so we hope to see you in that lesson.

As always if you have any questions or comments please leave them in the comments section below, and good luck with your trading!

Gaffa

Hi David,

I really like you analogy of "wind at your back" it something that I will keep in mind from this day forward.
You may be covering this in the future but I was thinking that because going long on the higher interest currency's is a popular strategy, wouldn't that demand drive the currency in question up? On a daily basis? And then down after the traders have taken both their profit and their "roll"? And couldn't we take advantage of both long and short trades here?
I would love to see some charts of the 5pm est cut off to see this in action.

Gaffa

David Waring

Hey Gaffa,

Glad you like that and yes that is very intuitive of you to think about rollover in that way.

As with anything in trading however, anytime there is something to be taken advantage of that is kind of in every one's face people do take advantage of it which changes the market dynamic.

With this being said one of the guys that I used to work with has a strategy for trading the price action on Wednesday when the rollover is triple that seems to have held up fairly consistently over time. I will see if I can get in touch with him and see if he has some info he is willing to share on it.

Best Regards,
Dave

zoglchaim

just a fast question here
i realized in your program pip cost 10.00
my demo account pip cost is 1 WHY?

Tekmnd

Hi zoglchaim,

A $10 pip means that it is a standard size contract ($100K of currency).
A $1 pip means it is a mini contract ($10K of currency).

There are also micro lots (micro contracts) where each pip is only 10 cents ($1k of currency).

Cheers
Tek

Unregistered

[QUOTE=David Waring;26491]Hey Gaffa,

Glad you like that and yes that is very intuitive of you to think about rollover in that way.

As with anything in trading however, anytime there is something to be taken advantage of that is kind of in every one's face people do take advantage of it which changes the market dynamic.

With this being said one of the guys that I used to work with has a strategy for trading the price action on Wednesday when the rollover is triple that seems to have held up fairly consistently over time. I will see if I can get in touch with him and see if he has some info he is willing to share on it.

Best Regards,


Hi David,

I was just wondering if you were able to get this info from your former colleague, because this rollover thing is "crystal ball" stuff.

David Waring

Hi there,

Glad to hear from you. No unfortunately since my former colleague now has a radio show which he charges for he does not want to give away one of his strategies for me to post on the board.

With this being said if you visit his site and contact him directly on an individual basis I would think he would be willing to pass the audio webinar he has on it along to you.

His name is Andrew and his website is Global FX Radio

Best Regards,
Dave

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Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.

augusttay

Hi Dave,
I am a newbie to trading and I have learned so much from your videos! You have explained the concepts so well in everyday language. If only I have watched your videos before those books I read, my learning would have been easier.

David Waring

Hi Augusttay,

Glad to hear from you and my apologies for the long delay in reply here. Also thank you for the compliment I am glad that you are finding our videos useful and look forward to seeing you around the community.

Best Regards,
Dave

__________________
InformedTrades University | IT Shopping Guide | Site Map


Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.

nicaro

I am not sure exactly which interest rate, as it pertains to the U.S. central bank, we are suppose to take into consideration when we consider a carry over trade.