This article looks at what carry trading is and why there is a recent decline in its profiting on the foreign exchange rate market.
There are various types of foreign exchange rate trading strategies available to traders including day trading and scalping. However, in recent years the most common has been noted as foreign exchange rate carry trading. This trading strategy is quite alternate to the other styles being entirely dependent on the global economy. Many traders argue that carry trading is not a trading strategy, but rather a money making opportunity.
Presently, this strategy has been showing less profitability than before despite its popularity. The decline in favourable outcomes can be analysed by looking at market conditions. This article will look at both the definition of carry trading and its current outcomes.
Foreign exchange rate carry trading
Before one can understand why carry trading is not a profitable option, one must understand what carry trading is and how to use it. Carry trading is where a foreign exchange trader will earn money from the rise of decline of a chosen currency pair using the interest rate variance between the two currencies. The carry trader will buy the currency with the higher interest rate and sell the currency with the lower rate. Generally, this type of trader is more interested in the positive rate gained on the currency pair rather than the profits made on the trade itself.
The decline in carry trading
There are three primary concepts that have led to the decline of profits in a seemingly flawless trading strategy – an increase in risk aversion, a decline in interest rates, and government intervention. It should be noted that the volatility of the foreign exchange market can play a role in determining the outcomes of a carry trade. All forex trades have a degree of risk and carry trading is no different.
Below is a discussion of the three concepts that influence the decline in carry trading profitability:
1. An increase in risk aversion
The foreign exchange rate market is a volatile environment; however, an increase in the currency market can cause more risk aversion among investors. This increase in market volatility is often indicated by the large increase in daily ranges. When this happens the investors will close high risk positions and stocks will decrease. Carry traders will consequentially close their carry trading positions as the market is too uncertain for a stable carry trade.
2. A decline in interest rates
Due to the increase in unstable global economies, many countries have started cutting interest rates. This cut in interest rates has caused both traders and money managers to reconsider their long-term carry trade positions. The percentage they originally received has now reduced tremendously making these positions no longer worthwhile, leading to asset recollection and cutting of losses.
3. A government intervention
Although it is rarely seen, government intervention can affect foreign exchange rate carry trading. This occurs when a country’s currency either rapidly increases or decreases unexpectedly. Carry traders have been seen to close trades immediately to avoid any detrimental losses.