Page 154 - Ultimate Guide to Currency Trading

currency. The idea behind choosing a good funding currency is shorting a very low-yielding currency

such as the Swiss franc, USD or the Japanese yen. These currencies have historically been used as
funding currencies because they have had low interest rates.

Once you decide upon a low-yielding funding currency, you would go long a currency that is
paying a high interest rate. Classic examples can be found by looking toward the commodity

currencies such as the Australian. New Zealand, and Canadian dollars. Other classic currencies include
the high-yielding South African rand and the Norwegian krone.

The idea is that you would short the low-yielding currency and go long the high-yielding
currency. Behind the scenes you would be paying interest on the shorted currency (as it is a loan), and

you would be earning interest on the higher interest-bearing long currency (as it is an investment).
This is the basic method of how all currency pairs are funded, the only difference is that you usually do

not notice the interest earned because currency trades usually have a length of only a few minutes,
hours, or days.

Even if you are in an FX trade as a carry trade, you should have no hesitation to
close out the trade when the pair gets profitable. Forex pairs that are used as carry

trades can go up in price rapidly. You might find your carry trade turns out to be a
Essential
capital gain that becomes too tempting to pass up.

On the other hand, when you are getting into a currency pair with the intent of a carry trade,

then the interest you will be earning will be com-pounded over weeks, months, seasons, and even

years. While the currency pair goes up and down, you will earn the difference between the interest of
the low-yielding currency and the high-yielding currency. Not only will you earn the difference, you

will earn that interest second by second, with payouts once a day. This continuous compounding can
add up very quickly.

Carry trades are considered very low risk, and if timed properly can go on for a long time. The
interest earned can be up to 5 percent or higher. If you are trading one-third of your account at 50:1,

the interest that you would earn would be over 80 percent of your total account balance. In other
words, if you have a $1,000 balance, you would earn over $800 in interest per year (if the interest

difference was 5 percent).