What is a carry trade?
In one line: A carry trade means holding a higher-interest currency, paid for with a lower-interest one, to collect the gap between their interest rates.
The short answer
Every currency comes with an interest rate set by its Central bank. A carry trade buys the currency that pays more and sells the one that pays less.
Hold the trade overnight and you may collect the difference each day, through the Swap (rollover).
A simple example
Imagine two made-up rates:
- Currency A pays 4.5% a year.
- Currency B pays 0.5% a year.
The gap, called the Interest rate differential, is 4.0%.
You buy A against B with 1 standard lot, about $100,000 worth. In a year, the gap is worth about:
$100,000 × 4.0% = $4,000, or roughly $11 a day.
Brokers take a cut, so the real swap is smaller. And that's only the interest. If currency A falls 5% against B, the price loss is about $5,000, more than a year of interest. A math example, not a promise.
Why people use it
Pairs like AUD/JPY and other yen crosses became classic carry trades, because Japan's rates were very low for many years.
When markets are calm, carry trades are popular, and money flowing into the higher-rate currency can support it.
The risk: the unwind
Carry trades tend to unwind all at once. When fear hits, everyone rushes to close them together. The low-rate currency, often the yen, can jump fast.
That happened in early August 2024. After the Bank of Japan raised rates and US data came in weak, many yen carry trades were closed quickly. The yen rose sharply, and Japan's Nikkei 225 index fell about 12% on August 5, its worst day since 1987.
The steady interest is small. The sudden loss can be large.
A common mistake
Ignoring the price because the swap is positive. A daily credit feels like safe income. But one bad week in price can wipe out months of interest. The carry doesn't replace a Stop loss.
Size the trade from the stop, not from the interest. Use the position size calculator, and remember Leverage makes both the interest and the losses bigger. More on fear-driven moves in Risk-on and risk-off.
Questions
Is the carry trade risk-free?
No. The interest is small and steady, but exchange rates can move against you far more than the interest pays.
What is the yen carry trade?
Borrowing or selling Japanese yen, which had very low rates for years, to hold higher-yielding currencies or assets.
Do you earn carry on every forex trade?
Only if you hold past the daily rollover time, and only on the side that's long the higher-rate currency. The other side usually pays.
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