I don’t have much experience trading the forex (or FOReign EXchange) market but my curiosity has been reignited as I’ve seen the dollar gain so much strength in recent weeks. I’ve had an Oanda FXTrading account for a while but only recently started to place trades. So far my dumb-founded bets have been successful, but we’ll see how long this lasts.
One part that really intrigues me about forex trading is what’s apparently referred to as a carry trade. Let’s say I deposit $1000 USD into my oanda account. With this, I can leverage 1:50 and control up to $50,000 USD worth of different currencies. I don’t margin anywhere close to this ratio because it’s far too risky for me, but it is possible.
So with a $1000 account leveraged lets say 1:10 I can buy $10,000 USD worth of currencies and profit from the change. The Carry Trade comes in when you make a profit not only off the appreciation of the currency but also off the interest. If I buy 10,000 units (a $7,600 USD position) of the Austrian dollar earning 5.1% interest and sell the Japanese Yen where I have to pay .135 interest…each day I make $1.05 USD on interest alone.
The question becomes do interest rate differentials correlate to the appreciation of a currency? Theoretically I think the answer is yes, however in practicality, I think it’s far from true. Investopedia has a better explanation of a carry trade here.