Carry Trade

A carry trade is a position that holds a higher-yielding currency against a lower-yielding one to earn the gap between their interest rates. On a leveraged FX position, that gap is paid or charged daily as swap (rollover). The carry trader's ideal world is a wide, stable rate gap and calm markets: the position pays them every day just for existing.

The mechanics

Every currency pair has two interest rates behind it. Long the pair means holding the base currency and financing it in the quote currency; whether you receive or pay swap depends on which rate is higher. The size of the daily payment scales with the interest rate differential, which is why carry strategies concentrate in the pairs with the widest gaps.

When carry works and when it breaks

Carry performs in risk-on conditions: low volatility, decent growth, no shocks. It breaks in risk-off. Because so many traders hold the same high-yield positions, a shock forces simultaneous exits, and the funding currency, often the yen or the franc, spikes as positions are bought back. These unwinds are fast and deep; the steady daily income hides a short, violent tail risk.

Positioning data warns when the trade is crowded. A historically stretched net position in COT data says the carry crowd is all-in, which raises the stakes of any risk-off trigger.

Beyond the daily swap

Carry also shapes longer-term flows: capital migrates toward currencies whose expected rates are rising, which is why shifts in the expected differential move pairs before any rate actually changes. Our carry trade guide walks through the full strategy, and the anatomy of a rate differential covers the mechanics in depth.

A worked example

Suppose the base currency of a pair yields 4.50% and the quote currency 0.50%, a 4 percentage point gap. On one standard lot (100,000 units), holding the higher-yielding side earns roughly 100,000 × 4% / 365 ≈ 11 dollars per day before broker costs, since brokers pass the differential through with a spread. Eleven dollars a day is about 4,000 a year on that position if nothing moves. Now note what a single 2% adverse move does: 2,000 dollars, half a year of carry, gone in a day or two. That asymmetry is the whole character of the trade.

Common mistakes

The classic error is sizing a carry position like a normal trade. Because the daily income is small and steady, traders stack size to make it meaningful, exactly the posture that gets destroyed in an unwind. The second error is holding through a regime change: when volatility spikes and risk-off takes over, the rational carry trader reduces first and asks questions later, because everyone else in the crowded trade is heading for the same exit.