Definition
Carry TradeA carry trade is buying a higher-yielding currency against a lower-yielding one to earn the interest rate difference, while accepting exchange rate risk.
Example
If one currency pays a policy rate of 5% and the other 0.5%, a trader long the high-yielder and short the low-yielder aims to earn roughly the 4.5% gap per year, minus broker costs.
In detail
Every currency has an interest rate attached to it, broadly set by its central bank. When you hold a forex position overnight, you are effectively borrowing one currency and depositing the other. If the currency you are long pays more interest than the one you are short, you may receive a positive swap each day. That daily income is the "carry."
A carry trade deliberately targets this income. The trader buys the high-yielding currency and sells the low-yielding one, hoping the exchange rate stays stable or moves in their favor.
Example
Assume (illustratively) Currency A has a 5.00% rate and Currency B has a 1.00% rate, giving a 4.00% interest rate differential. A trader goes long A/B with a notional value of 100,000 units of Currency A.
- Gross annual carry: 100,000 × 4.00% = 4,000 units of A
- Approximate daily carry: 4,000 ÷ 365 = about 10.96 units per day
In practice, brokers apply a markup, so the actual swap credited is smaller than this gross figure, and it can even be negative.
Now the risk: if A/B falls 5% over the year, the position loses about 5,000 units of A in value, wiping out the entire carry and more.
Why it matters
Carry trades link forex to global interest rates and risk appetite. They tend to do well in calm markets and can unwind violently when fear rises, because many traders try to exit the same crowded positions at once. Moves that took months to build can reverse in days.
Using leverage magnifies both the carry and the exchange rate risk. The interest earned is usually small relative to potential price swings, so carry traders still need clear risk management. The Interest Rates and Currencies lesson explains the underlying mechanics.
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Related terms
- Interest Rate DifferentialThe interest rate differential is the gap between the interest rates of the two currencies in a pair. It drives swap rates and influences capital flows.
- SwapA swap, or rollover, is the overnight interest credited or debited when a forex position is held past the daily cut-off, based on the two currencies' rates.
- Central BankA central bank manages a country or region's money supply and sets its key interest rate, making it one of the strongest drivers of currency values.
- VolatilityVolatility measures how much and how quickly a currency pair's price moves. Higher volatility means bigger swings, which raises both opportunity and risk.
- LeverageLeverage lets you control a position larger than your own deposit by using borrowed exposure from your broker. It magnifies both profits and losses.