Currencies are always traded in pairs inside of the market. Think of combinations such as USDJPY and the like. These are all pairs that you can potentially trade when you are in the market. What is important to remember is that you pay the interest on pairs that you SELL. However, you earn interest on the pairs that you BUY.

The importance of all of this is that you can potentially make some money for yourself no matter which side of the trade you get in on as long as you are diligent about making sure you know which sides pay and which do not.

From a technical perspective, all positions are closed out at the end of the Forex trading day. You don’t see this happen in your account if you decide to hold until the next trading day, but this is technically how it works. Thus, at the end of the trading day, it is necessary for the interest differential between the two currencies to be considered and accounted for.

The carry trade is very popular with some traders because of the amount of leverage that many Forex brokers offer at this time. Those who carry their trade over to the next day can continue to earn a profit on their trade day after day simply from the interest of the carried trade. They may or may not be losing money in the market over this period of time because of their trade, but they can at least collect a little interest between the currency that they buy and the one that they sell.

Example of How This Works

Taking a look at a simple example will help better explain how a carried trade works and why it is important.

Trader A has $10,000 to use in the Forex market for trading. He could put that money into a bank account instead and earn 1% on the money for the whole year, but they will only be $100 richer at the end of the year if they do so. Instead, Trader A can choose to look for a carry trade opportunity in the Forex market.

In this example, Trader A has a broker that offers 100:1 leverage. Thus, Trader A chooses to use $1,000 of his money to control $100,000 worth of a currency. The interest differential on the pair that Trader A has discovered is 5% for the year. Thus, they can earn a 5% annual interest rate on $100,000 worth of currency. If Trader A places the trade and allows it to sit for an entire year, there are three scenarios that can play out.

The Position Loses Value

If the position falls like a rock, then the account could be wiped down to all that is left for the margin (or $1,000). However, at least some carried interest will have been earned daily during that time to offset the loss to some extent.

The Pair Stays at Roughly the Same Rate

The Trader has not earned money on an increase in value of the currency, but he or she has collected some additional value on the carried interest that has played out throughout the account for the entire year. Thus, it is possible that they earned as much as $5,000 (5% of the $100,000 trade) on a $10,000 account on interest alone.

The Pair Increases in Value

Now, not only does Trader A earn money on the increase in value of the pair, but the carried interest adds even more juice to the trade, and it is possible that they can earn both on the interest rate paid on the trade as well as on the increase in value of the trade itself. That is a sweet deal for Trader A, and it is a great way to make the most of a carried trade.