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The Carry Trade: A Simple, Effective Strategy for Beginning Currency Traders

Many traders new to the currency market find it overwhelming:

..they think they must analyze the whole entire world and everything in it to find trading opportunities. In reality, though, there are several simple and effective strategies a beginning investor like you can use to grow consistent, steady and reasonable returns over time. One such strategy is a currency investment known as the "carry trade" approach. In it, you trade international currencies against each other by simply buying currencies with a higher interest rates and selling those with a lower rate. Over time, capital tends to flow to currencies that offer a higher interest for holding it, thus leading to a rise in the value of currencies with a higher interest rate. This simple strategy has been recommended by many esteemed forex traders, from fund managers like Bill Lipshultz to educational organizations like Forexmentor.

One example of this concept in action can be seen in the Australian dollar/US dollar exchange rate over the past 10 years. The Australian dollar has consistently maintained a higher interest rate relative to the US dollars, so that those holding Australian dollars in an Australian bank would earn more for simply holding it than holding US dollars in a US bank account that offered an interest rate that has been several percentage points lower over the past decade. The chart below shows how the Australian dollar has risen in value relative to the US dollar.

A Carry Trade approach over the last 10 years would have yielded significant returns. Over the last five years (beginning at and coinciding with the global recession) the "low/high" difference is just as pronounced over a shorter period.

It's best to put this trade on when the low-interest bearing currency is rallying against the high-interest bearing currency. That's when you sell the former and buy the latter. For instance, when the US dollar rallied sharply against the Australian dollar in 2008 in spite of having a lower interest rate, that offered traders a prime opportunity to sell the US dollar at a higher price and buy Australian dollars at a lower price. When this concept is applied to two currencies of larger, more developed economies -- such as Australia and the US -- the result is precisely what the chart above illustrates over a several year period.

To put it simply, carry trading works. If investors are willing to apply this simply strategy with discipline and with patience, the result will be positive results over a multi-year basis.

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