Posted by forex at 4:16 AM
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1. Determine the interest rates of both the base and quote currency in the currency pair you are trading. The first currency is the base and the second is the quote, so in the AUD/USD pair, the Australian dollar is the base currency and the U.S. dollar is the quote currency. As of October. 2010, the interest rate on the AUD is 4.25 percent, while the interest rate on the U.S. dollar is .25 percent.
2. Assess the interest rate difference in relation to your position. Taking the interest rates from step one, you can see that there is an interest rate differential of 4 percent. Therefore, when you hold a long position in the AUD/USD, you benefit by receiving a daily rollover credit that represents the 4 percent interest difference between the base and quote currencies.
3. Compare the interest rate difference with your margin. In a carry trade, the interest rate difference is credited to your account based on the size of your position. This means that in a standard contract, interest is credited on 100,000 units of currency rather than the amount of margin you must deposit to trade the contract. This means that the actual return on investment in a carry trade is larger than the percentage earned on the position. For example, if you are trading $100,000 worth of currency on 50:1 margin, you only need $2,000 margin. If the interest rate difference is 4 percent in your favor, you will earn $4,000 a year on your position. However, with a margin requirement of only $2,000, you actually earn 200 percent on your investment.