Carry trade involves going long on a higher-yielding currency while shorting a lower-yielding one. In other words, to benefit from positive carry, you have to buy a currency with a higher interest rate against a currency with a lower interest rate. The interest rate differential will allow you to make profits if you hold on to the trade for at least a day even if price doesn't move at all.
For example, you can buy the Australian dollar against the euro and earn a positive interest rate differential of 2%. Of course this assumes that the RBA gives an interest rate of 2.50% and the ECB is currently offering an interest rate of 0.50%. Using the right account size and enough leverage, plus the number of days you hold on to the trade, you can enjoy compounded interest also.
Holding on to a trade for more than a day means that brokers have to close and reopen your trade, even if you don't see this actually happening right on your platform. In this process, the interest rolls over to the next day and gets debited to or credited from your account.
Carry trade can work against you too if you are short a position on a higher-yielding currency versus a lower-yielding one. For example, if you are selling New Zealand dollars in exchange for U.S. dollars and you held on for a day, you get a -1.50% return since the RBNZ gives a rate of 2.00% while the Fed has 0.50%.
Remember also that risk sentiment must be on your side when taking advantage of carry trades. This means that market sentiment should be favoring a rally of higher-yielding currencies versus lower-yielding ones, as traders would rather take on more risk. This way, you can have positive returns from your forex trade and add to your wins with the positive interest rate differential. On the other hand, when risk is off and higher-yielding currencies are selling off, you can still earn from positive carry but lose on your forex trade.
To summarize, there are two major things you need to look for to profit from carry trade. First is the positive interest rate differential in buying a higher-yielding currency versus a lower-yielding one. Second is risk appetite, which should keep the higher-yielding currency rallying against the lower-yielding one.
For example, you can buy the Australian dollar against the euro and earn a positive interest rate differential of 2%. Of course this assumes that the RBA gives an interest rate of 2.50% and the ECB is currently offering an interest rate of 0.50%. Using the right account size and enough leverage, plus the number of days you hold on to the trade, you can enjoy compounded interest also.
Holding on to a trade for more than a day means that brokers have to close and reopen your trade, even if you don't see this actually happening right on your platform. In this process, the interest rolls over to the next day and gets debited to or credited from your account.
Carry trade can work against you too if you are short a position on a higher-yielding currency versus a lower-yielding one. For example, if you are selling New Zealand dollars in exchange for U.S. dollars and you held on for a day, you get a -1.50% return since the RBNZ gives a rate of 2.00% while the Fed has 0.50%.
Remember also that risk sentiment must be on your side when taking advantage of carry trades. This means that market sentiment should be favoring a rally of higher-yielding currencies versus lower-yielding ones, as traders would rather take on more risk. This way, you can have positive returns from your forex trade and add to your wins with the positive interest rate differential. On the other hand, when risk is off and higher-yielding currencies are selling off, you can still earn from positive carry but lose on your forex trade.
To summarize, there are two major things you need to look for to profit from carry trade. First is the positive interest rate differential in buying a higher-yielding currency versus a lower-yielding one. Second is risk appetite, which should keep the higher-yielding currency rallying against the lower-yielding one.