Cost of Carry

In forex, the Cost of Carry refers to the expenses incurred when holding or carrying a position in a currency pair overnight. It represents the cost or benefit associated with holding a position in a currency pair from one trading day to the next.

The Cost of Carry is composed of two main components:

1. Interest Rate Differential: The interest rate differential refers to the difference in interest rates between the two currencies in a currency pair. Each currency has an associated interest rate set by its respective central bank. The difference in interest rates creates a cost or income source when carrying a position in a currency pair. When buying a currency with a higher interest rate, you are essentially paying the lower interest rate currency, which is reflected as a carrying cost.

For example, let’s consider the EUR/USD currency pair. If the interest rate in the Eurozone is 1% and the interest rate in the United States is 0.5%, then the Cost of Carry for holding EUR/USD overnight would be positive, meaning you would have to pay USD to buy EUR.

2. Swap Costs: A swap is the interest rate differential applied when carrying a position in a currency pair overnight. Swap costs represent the interest amount paid or received for carrying a position to the next trading day. Swap costs are a part of the carrying cost and can vary based on overnight interest rates.

The Cost of Carry is typically associated with long positions (buying one currency and selling another). However, in some cases, short positions (selling one currency and buying another) may also incur carrying costs. This depends on the trader’s position in the currency pair and market conditions.

The Cost of Carry is particularly important for long-term traders and those employing carry trade strategies in the forex market. Carry trade is a strategy where an investor buys a currency with a higher interest rate and sells a currency with a lower interest rate, aiming to profit from the interest rate differential as a carrying cost.

In summary, the Cost of Carry in forex refers to the expenses incurred when holding or carrying a position in a currency pair. It consists of the interest rate differential and swap costs. The Cost of Carry is relevant for long-term traders and those employing carry trade strategies.