A Carry Trade involves selling a currency at a low interest rate and purchasing a currency that has a a high interest rate with the intention of gradually yielding a profit over time. You can think about it like buying a stock for dividends.
At the moment interest rates are near all time lows as Banks around the world tried to spur spending. This means that carry trading holds a low incentive as the biggest range in interest rates you can currently trade is 1%. This is historically very low and means carry trading is not very lucrative.
However as economic growth picks up and inflation rises, Central Banks around the world are looking at the possibility of re-raising interest rates. This opens the opportunity to carry trade.
How do you Carry Trade?
The incentive behind carry trading is that the odds are always in your favour. We know that interest rates are the biggest influencer of currency markets, so by trading in the direction of the currency with higher interest rates, we not only stand to profit from interest, but also stand a high chance of profiting by the currency we’ve bought appreciating while we hold it.
To enter a carry trade you can either find a currency pair with a large difference in rates or try to predict future rate changes, this is more risky but carries more potential for profit as shown by the incredible dollar bull run after the Fed announce they intend to hike interest rates.
Your broker will give you a quote for overnight swap, if your buying a currency with a higher rate than the one your selling this will be likely be positive meaning you will be paid and vice versa.
You should also check for economic news related to the currency your selling, high CPI and retail sales figures may be signs you should look for a different pair.