Carry trade involves going long on a higher-yielding currency while shorting a lower-yielding one. In other words, to benefit from positive carry, you have to buy a currency with a higher interest rate against a currency with a lower interest rate. The interest rate differential will allow you to make profits if you hold on to the trade for at least a day even if price doesn’t move at all.

For example, you can buy the Australian dollar against the euro and earn a positive interest rate differential of 2%. Of course this assumes that the RBA gives an interest rate of 2.50% and the ECB is currently offering an interest rate of 0.50%. Using the right account size and enough leverage, plus the number of days you hold on to the trade, you can enjoy compounded interest also.

Holding on to a trade for more than a day means that brokers have to close and reopen your trade, even if you don’t see this actually happening right on your platform. In this process, the interest rolls over to the next day and gets debited to or credited from your account.

As you probably noticed, carry trade can also work against you if you short a higher-yielding currency against a lower-yielder. For instance, you can short New Zealand dollars against U.S. dollars and you could incur -1.50% on your account. This is because the RBNZ currently has 2.00% interest while the Fed gives 0.50% only.

Traders take advantage of positive carry when risk is on. In this scenario, traders are buying up higher-yielding currencies as they pursue more risk and reward. Not only do you earn from the trade itself as it goes in your favor, but you also incur additional interest on the positive carry. However, when risk appetite is down and traders are selling higher-yielding currencies as they seek safe-haven ones, you might be able to earn from positive carry but your wins will be erased by your losing forex position.

To summarize, there are two major things you need to look for to profit from carry trade. First is the positive interest rate differential in buying a higher-yielding currency versus a lower-yielding one. Second is risk appetite, which should keep the higher-yielding currency rallying against the lower-yielding one.

Heres a quick recap on the 3 factors moving the USD these days.