Carry Trade Strategy: Overview and Backtest Analysis

If you are active in the financial markets, you may have heard of carry trade, especially in currency trading. It is becoming increasingly popular among retail traders. But what does the carry trade strategy mean?

A carry trade strategy involves borrowing at a low-interest rate currency and converting the borrowed amount into another currency with a higher interest rate to invest in an asset that provides a higher rate of return.

In currency trading, it typically involves selling a currency with a low-interest rate and buying a currency with a higher rate. But the strategy can be applied to other assets when the borrowed amount is deployed into assets such as stocks, commodities, bonds, or real estate denominated in the second cu

Want to know more? Let’s dive in. At the end of the article, we provide some facts about carry trade backtests.

What is carry trade?

A carry trade strategy entails borrowing at a low-interest rate from one currency and investing in an asset that provides a higher rate of return in another currency.

In other words, borrowing in a low-interest rate currency and converting the borrowed amount into another currency. The proceeds would typically be deployed into certificates of deposits in the second currency that offers a higher interest rate, but they could also be invested in other assets, such as stocks, commodities, bonds, or real estate, denominated in the second currency.

While this kind of trade can be profitable, it is never without some risks, which include a sharp decline in the price of the invested assets and exchange risk, or currency risk, when it involves two different currencies. Given the risks involved, carry trades are appropriate only for investors with deep pockets and who “know what they are doing”.

Carry trade currency pairs

The carry trade strategy is most popular in forex trading, where it involves buying a currency pair with high-interest rate spreads — the base currency has a high-interest rate. In contrast, the quoted currency h