What is the Carry Trade, and how does it work?

Did you know that if the price remains the same for an extended length of time, there is a trading method that can make money？

There is, and it's one of the most popular strategies to make money among many of the financial universe's largest and baddest money manager mamajamas!

It's known as the “Carry Trade.”

“I'm tired of lugging things everywhere!”

What is a Carry Trade, and how does it work？

A carry trade entails borrowing or selling a low-interest-rate financial instrument and then using the proceeds to buy a higher-interest-rate financial asset.

You are earning higher income on the financial instrument you acquired while paying a lesser interest rate on the financial instrument you borrowed/sold.

So the money you make from the interest rate disparity is your profit.

Example of a Carry Trade:

Let's imagine you want to borrow $10,000 from a bank.

Every year, they charge 1% of the $10,000 in loans.

You use the money you borrowed to buy a $10,000 bond with a 5% annual interest rate.

What is your profit margin？

You figured it out! It's a 4% annual increase! The distinction in interest rates!

“That doesn't sound as interesting or profitable as capturing market swings,” you're probably thinking.

When it comes to the spot FX market, however, with its larger leverage and daily interest payments, sitting back and watching your account increase everyday might be rather enticing.

To give you an idea, a 3% interest rate disparity on a 20-time leveraged account translates to 60% annual interest in a year!

Example of a Leveraged Carry Trade:

Let's imagine you borrowed $1,000,000 with a 1% interest rate.

However, the bank will not lend a million dollars to just anyone. You must put up $10,000 in cash as security.

Once you've paid back the money, you'll get it back.

Your loan has been approved, so stock up on supplies.

Then you turn around and walk across the street to another bank, where you deposit the $1,000,000 in a 5-percent-a-year savings account.

A year has gone by. What is your profit margin？

The bond paid you $50,000 in interest ($1,000,000 *.05).

Interest was paid in the amount of $10,000 ($1,000,000 *.01).

So you've made a profit of $40,000 after expenses.

You made $40,000 on a meager $10,000 investment!

That's a 400% return on investment!

We'll go through how carry trades work, when they'll work, and when they won't work in this part.

We'll also address risk aversion.

What the hell is that？!

Don't worry, we'll talk about it more later.