The Carry Trade

The Carry Trade is a long-term strategy that can either be used itself as a long-term trading strategy OR as a way to select which pairs you should be trading, and in which direction.

The idea behind the strategy is very simple: over the short term, money tends to flow AWAY from currencies with LOW interest rates, and TOWARDS currencies with HIGH interest rates.

All you need to do is check what the major currencies' base rates are, and look to be long the relatively high ones (at the time of writing, these are NZD and AUD) and short the relatively low ones (at the time of writing, these are JPY, EUR, and USD).

If you are trading on relatively short time frames, this can help you decide which pairs to trade and in which direction. For example, at the moment you might be looking for NZDUSD to pull back to support and turn around, before going long.

If you are prepared to trade on very long-term time frames with very small positions, you could even do it without a stop loss as long as you monitored the trade - but ONLY with VERY SMALL positions. You might still want to put in an emergency stop loss for peace of mind.

With the exception of the period of the financial crisis from summer 2007 to spring 2009, even sucha  simple strategy produced an upwards-sloping equity curve.

You can also use this strategy to give extra weight to other long-term trading strategies. For example, if you see a currency with a relatively high interest rate is starting to get a long-term upwards trend going, its high rate could give you extra confidence in being long of that currency.

It should be said that this kind of strategy performed very well from 2001 to mid-2007, but was only mediocre during 2010 to 2012, but since then it has been performing much better.

It can be said that the strategy has a long-term edge which is backed up by classical economic theories. Having said that, these theories also hold that in the very long term, a high rate of interest should not be enough to maintain a currency's strong valuation against other currencies.

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