Between 2003 and 2004, the  currency trader was getting a 2.5% positive yield spread with the AUD/USD . This might appear very small, but the return, with using a 10:1 leverage would become 25%. At this time, the AUD had rallied up from 56 cents closing at 80 cents against the USD, representing a 42% appreciation between the currency pair. If you had been in this trade – at the time many hedge funds were – then you would have earned not only the positive yield, you would have seen exceptional capital gains too for your underlying investment.

In 2005 the USD/JPY saw a magnificent Forex carry trade opportunity. Over that year, from January to December, the currency rallied and from starting at 102 to reaching the height of 121.40 and finished at 117.80 equalling an appreciation from the low to the high of 19%, far more attractive you’ll agree than the measly 2.9% return in the S&P 500 during the same period. In addition, the interest rate spread at the time between the US dollar and Japanese yen was averaging around 3.25%. Without leverage, this meant a trader might have profited by 22.25% over the duration. Introduce leverage at 10:1, and a 220% gain could have been possible.

Carry Trade Success

Creating a Forex carry trade strategy that will be successful does not equate to simply pairing up the highest interest rate currency against a currency showing the lowest rate. Much more important is the spread direction rather than the absolute spread itself. For a carry trade to work best, there must be long position on a currency where the interest rate is in the process of expanding against another currency showing a contracting or stationary rate of interest. This dynamic will be true if the central bank in the country where you are long is seeking to raise their rates of interest or if the central bank in the country where you are short is looking to lower their rates of interest.

>>>  Click here to read Part 4 on Currency Trader Basics  >>>