Carry trade operation on Forex implies simultaneous conclusion of two opposite trades with different settlement dates, i.e. a position closes already opened one, while the other opens it at the same time. Thus, carry trade is a combination of two deals with the same amount of money and different fixed value dates made in opposite directions.
The main purpose of such strategy is an overnight trading.
In carry trading the short (bought) currency is hypothetically put on deposit, while the funding (sold) currency is borrowed. As the position’s expiry dates are not specified beforehand, the money is deposited and credited overnight.
The strategy only works if a broker supports swap trading. Swap crediting and withdrawal are based on the difference between the deposit and credit rate. If the deposit rate is more than the credit one, the swap (positive carry) is credited to a trading account. If the credit rate is higher than the deposit one, then swap (negative carry) is withdrawn from a trading account.
As an illustration, we will employ an interest rate to calculate the swap. Thus, the ECB's interest rate is 1%, in the USA it is 0.25%. We sell or buy 1 EUR/USD lot (1 InstaForex lot = 10,000 of a base currency, to wit EUR) at 1.2310. Annual swap will total ((1% – 0.25%) x 10,000 x 1.2310) / 100% = $92.325, or daily: $92.325 /365 = $0.25.
If we go long (buy position) on EUR/USD, then we borrow the dollars under 0.25% annual rate and deposit the euros at 1% annual interest. The deposit rate is higher than the credit rate, that is why we will be credited $0.25 to a trading account.
If we go short (sell position) on EUR/USD, we borrow the euros at 1% annual interest and deposit the dollars at 0.25% annual interest rate. The lending interest rate is more than the deposit rate, thus $0.25 will be withdrawn daily from a trading account.
The swap is tripled for a rollover from Wednesday to Thursday. It happens due to settlement date which is shifted to Friday. When we hold an overnight position from Wednesday to Thursday, the settlement date should be not 1 but 3 days, i. e. Monday. For this reason Wednesday-Thursday swap is calculated threefold.
Carry trade strategy works effectively on interest rate differential with such currency pairs as NZDJPY, AUDJPY, and the others.