Carry Trading in Forex Trading Strategies - Criteria for Selecting Carry Trading Currency Pairs and the Risks of Carry Trading

Criteria for selecting carry trade currency pairs

It is very easy to find the right currency pair to carry a carry trade. As long as the following two points are met, we can consider a carry trade.

1. Find currency pairs with high interest spreads

2. Find a currency pair that remains stable, or find a currency pair that is in an upward trend and has a high-yielding currency that continues to appreciate in the currency pair.

Simple, right? Let's look at a real-life example of the carry trade.

Above is a weekly chart of AUD/JPY. Until recently, the Bank of Japan maintained a "near zero" interest rate policy.

The Australian dollar has the highest interest rate among major currencies (4.5% as of September 2010), and many traders choose to carry the AUD/JPY carry trade, which is also one of the reasons why the AUD/USD is in a stable upward trend.

From 2009 to early 2010, the AUD/JPY rose from 55.50 to 88.00, an increase of 3,250 points.

If you consider this factor in conjunction with the AUD/JPY spread, AUD/JPY represents a good long-term investment opportunity for some investors and traders who can discern currency market volatility.

Of course, economic and political factors change the world every day. Currency spreads are also likely to change, which could push popular carry trades, such as the yen carry trade, out of favour.

What are the risks of carry trades?

Since you are a very savvy trader, you already know what the first question you should ask is before you start trading.

"What's my risk?"

Completely correct! Before entering into a carry trade, you must always weigh the maximum risk you can take to determine whether you are worth the trade.

In our last lesson, our foreign exchange trading novice Zhang San, his maximum risk tolerance is $9,000. Once his losses hit $9,000, he will be automatically positioned squaring by the system.

That doesn't sound very good, does it?

Remember, this is the worst possible scenario for Zhang San, because he has not yet fully realized the value of the stop loss.

When making carry trades, you can also use a stop-loss strategy like a normal directional trader.

For example, if Zhang San wants to limit his maximum loss to $1,000, he can set his stop loss at any price that causes him to lose $1,000. As long as he holds the position, he can still earn interest income.