The Carry Trade
Buy the high-yielding currency, sell the low-yielding one. Collect the difference daily.
Researched and written by Laurent The Concept
The carry trade is one of the oldest and most straightforward strategies in forex. The idea: borrow in a low-interest-rate currency and invest in a high-interest-rate currency, pocketing the difference.
In practice, when you go long AUD/JPY (buy AUD, sell JPY), you're effectively borrowing yen (low rate) and investing in Australian dollars (higher rate). Your broker pays you the interest rate differential each night as a "swap" or "rollover" payment.
AUD rate: 4.35% | JPY rate: 0.10%
Rate differential: 4.25%
If you hold 1 standard lot of AUD/JPY overnight, you earn roughly (4.25% / 365) of the notional position value per night. On a 100,000 AUD position, that's approximately 11.60 AUD per night in swap income.
Central bank rates change over time, so always check both currencies' current rates (and your broker's actual swap quotes) before entering a carry trade.
Why It Works (When It Works)
Carry trades are profitable for two reasons:
- The daily swap income: You earn money every night you hold the position, regardless of price movement.
- The trend effect: When carry trades are popular, capital flows from low-rate to high-rate currencies, which tends to push the pair in your favor, adding capital gains on top of the swap income.
This is why carry trades can be extremely profitable in stable economic environments. During the 2003-2007 period, NZD/JPY climbed steadily for years, paying carry traders both swap income and price appreciation.
The Risk: Carry Trade Unwinds
Carry trades have an Achilles' heel: they unwind violently during market panics. When a crisis hits (financial crash, pandemic, geopolitical shock), investors flee risk assets and rush to safety. They dump high-rate currencies (AUD, NZD, emerging markets) and buy safe havens (JPY, CHF, USD).
This is why JPY rallies sharply during crises. Trillions of yen-funded carry trades unwind simultaneously, causing massive JPY buying. A carry trade that took months to build profits can lose them in days.
Modern Carry Trade Considerations
Not all brokers pass the full interest rate differential to you as swap. Many retain a portion. Before entering a carry trade, check your broker's actual swap rates for the specific pair. The theoretical differential and the actual swap you receive can be quite different.
Also consider: swap-free (Islamic) accounts do not receive carry payments at all. If your account is swap-free, the carry trade strategy doesn't apply.
Key Takeaways
- • Carry trade = go long the currency with higher interest rate, short the one with lower rate.
- • You earn the rate differential daily as swap/rollover payments.
- • Popular carry pairs: AUD/JPY, NZD/JPY, USD/JPY (when rate differentials are wide).
- • Carry trades unwind violently during risk-off events, causing sharp moves in JPY and CHF.