Forex is one of those areas that many people find convoluted and confusing, but in reality, it is less complicated than it looks at a first glance. The forex market is basically a stock exchange where instead of dealing with bonds and shares, the trader follows currency pairings.
That being said, many rookie investors expect quick returns with minimal risk and once they realize that forex is not a get rich quick scheme, they become disillusioned with the domain and quit. There are many factors that come into play here concerning trading psychology and discipline that deserve a stand-alone write-up, but for the purposes of this article, we will be focusing solely on long-term strategies. Without further ado, here is the best high-interest rate forex strategy for new investors.
What is the Carry Trade?
The carry trade started sometime in the 1980’s, but only recently has it become more widely used amongst individual traders and investors. This particular method involves selling or borrowing something with a low interest rate and then using it to acquire a financial asset with a higher interest. In forex terms, it means buying a high yielding currency and funding with low yielding currency. Basically, this strategy can be boiled down to the old business aphorism ‘’buy low, sell high’’.
It is one of the most popular trading strategies in the forex market because, if applied correctly, it enjoys high rates of success. Most traders employ this strategy by purchasing currency pairs like New Zealand Dollar/Japanese yen and Australian dollar/Japanese yen due to these pairs very high interest rate spreads.
How Does it Work?
The one characteristic (and advantage) that defines this particular trading strategy is that it allows interest earnings. More specifically, even if, for example, a trade is not moving, the account will have daily influxes of cash. Another aspect is that earnings will be determined not only by the size of capital, but by the size of the trade as well, since most forex trades are leveraged.
Carry trades are at their most effective when:
- The market volatility is at its lowest. When the market is stable and trades are less likely to fail due to a Pip movement, traders are more willing to expand their incomes by taking calculated risks. As long as the currency does not experience a fall, investors are practically paid while waiting from the leveraged yield.
- Central banks are, or are planning to increase the interest rates. Today, money can be moved from one country to another through the click of a mouse, and traders will not abstain from doing this if it allows them to pocket more money. Usually, when banks raise the interest rates, people will be rushing to the same carry trade, driving the value of the currency up.
Further on, carry trades fail to yield positive results when in one of these two scenarios:
- If a particular currency experiences a sudden, dramatic fall or rise, the Central Bank can intervene in the foreign exchange market to stop this process. Countries whose economies are dependent on exports can suffer from both an unreasonably strong currency, as well as a weak one. In first scenario, countries can lose a huge chunk of their earnings from exports, while companies with international reach can suffer huge loses in the latter case.
- In an inverted scenario, carry trades will fail if the Central Bank decides to reduce the interest rates. Again, the success of carry trades depends on the value of the currency pair remaining stationary. Reducing the interest rates will make foreign investors lose interesting in going long on the currency, and they will more than likely seek opportunities
Despite its name, the carry trade strategy is more suited to long-term investors than to traditional, day to day forex traders. A typical forex trader has to be constantly on the move, seeking new deals and information about potentially profitable currency pairs.
This does not mean that forex traders have to focus solely on short-term strategies or that they can’t employ the carry trade strategy effectively. Simply put, the kind of trader who seeks the thrill of risk in every deal might not benefit from this strategy as it might feel a tad dull.
On the opposite side of the spectrum, the carry trade comes with an ideal setup for traditional investors because once they invest, they do not have to worry about checking the prices on a daily basis. On top of that, they earn money by sitting patiently on the account with minimal, even inexistent intervention from their part.
The carry trade is considered by many forex experts to be the best trading strategy, and it’s no wonder why. From a risk-reward standpoint, the carry trade yields the best results on a consistent basis, and all one has to do is invest and wait for the money to line in. Before deciding whether to use it or not, traders must make sure to do proper research and find out which currency pair is appropriate to use.