It’s pretty simple to find a suitable pair to do a carry trade. Look for two things:
- Find a high interest differential.
- Find a pair that has been in an uptrend – where the currency you are long has been gaining value against the currency you are short.
Pretty simple, huh? Let’s take a real life example of the carry trade in action:
This is a weekly chart of GBP/JPY. Up until recently, the Bank of Japan has maintained a Zero Interest Rate Policy (current interest rate is 0.25% as of this writing - 11/01/2006). With the Bank of England touting one of the higher interest rates among the major currencies (currently at 4.75% as of this writing), many traders have flocked to this pair (one of the factors creating a nice little uptrend in the pair). From the end of 2000 to mid-2006, this pair moved from a price of 150.00 to 223.00 – that’s 7300 pips! If you couple that with interest payments from the interest rate differential of the two currencies, this pair has been a nice long term play for many investors and traders able to weather the volatile up and down movements of the currency market.
Of course, economic and political factors are changing the world daily. The interest rates and interest rate differentials between currencies may change as well, bringing popular carry trades (such as the Yen carry trade) out of favor with investors.