The world of sovereign currencies revolves around interest. Individual forex traders typically do not pay much attention to the interest paid or charged on currency pairs; this is because their positions are leveraged, and their brokers either take or absorb interest according to their management strategies. If you have enough funds in your client account to take positions equivalent to standard forex lots, you would not need to trade on margin, which means that you could get interest on positions you keep open overnight.
Every forex currency pair consists of money held and money owed. If you think you can profit by going long on the United States dollar versus the Japanese yen, for example, you should get interest on the greenback and owe interest on the yen as long as the position is open. This interest is paid and debited by your retail broker on a daily basis. We know the forex market is open for trading 24 hours a day, but in reality, all positions are closed and reopened when the clock strikes midnight on Greenwich Mean Time, which is 5:00 pm for American traders on the Eastern Standard Time zone. This is when interest transactions are executed.
Understanding and Utilizing Carry Trades
Carry trades are those forex positions held for more than 24 hours. If you have enough money to enter a standard lot of 100,000 units, you would not need any leverage, and the broker will not charge you any pips. In the USD/JPY example above, if the U.S. Federal Reserve has raised interest rates because the economy is running red-hot, you could benefit substantially from keeping the position open, particularly if the greenback is appreciating while the Japanese economy remains sluggish and the Bank of Japan is forced to keep interest rates low.
Institutional forex investors are known to make the most out of carry trades because of the interest they pay; furthermore, this interest compounds automatically as long as their investment goals are being met. If you ever find yourself in a position whereby you can manage standard forex lots without having to trade on margin, keep in mind that you could be profiting on the interest alone.