It turns out that it is actually possible to make money on a position that stays at roughly the same price for a long period of time. This strategy is known as the carry trade.
What is a Carry Trade?
This is a type of trade that one does when they borrow a low-interest currency to sell against a higher interest currency. The point of doing so is to claim the difference between the two as a way to make profit for yourself.
The difference between the interest rates is known as the interest rate differential, and it is how you can make money even on a trade that doesn’t necessarily move up or down much.
Example of a Carry Trade
Imagine that you borrow $10,000 from a bank at a 1% interest rate. You must pay the bank 1% of the loan balance each year. However, you can go out and invest that $10,000 to earn a 5% rate of interest on your money. If you do so, then you can claim the 4% difference between the two as your profit.
This is exactly how carry trades work on currencies with an interest rate differential and some of the most profitable traders in the world operate, and it works well for them from a profitability standpoint.
Think about it… if you use these principles in the spot forex market, with its higher leverage and daily interest payments, your account could potentially grow by leaps and bounds. For instance, a 4% interest rate differential transforms into 80% annual interest a year on an account that has 20:1 leverage.
Leverage Carry Trade
The best part about practicing the carry trade in the Forex market is the fact that you can use the leverage provided to you by your Forex broker to make even larger sums on your money. After all, you are going to be in control of a larger amount of the currency thanks to the leverage that they provide to you. Therefore, you can safely say that there is at least some chance that you will be able to earn more on the money that they have allowed you to control via leverage than what you ever would have controlled using just your own funds.
There are scenarios with a carry trade where you can certainly lose money. You need to think about how much risk aversion there is in the market at any time before diving right in. That said, it is possible to take some money to the bank by using a carry trade strategy if you choose to do so.