The forex carry trade: how it works and the risks

A carry trade buys a currency with a higher interest rate and sells one with a lower rate, aiming to earn the difference each night. It can pay steadily for months, then lose a large amount in days when markets turn.

How it works

Every forex position held past the daily rollover is charged or credited swap, based mostly on the interest-rate gap between the two currencies. If you buy the higher-yielding currency, you may receive a credit each night. If you sell it, you pay.

Brokers set their own swap rates and add a markup, so the credit you receive is usually smaller than the raw rate difference, and on some accounts it can even be negative. Check your broker's swap table before relying on it. See forex swap rates explained.

A simple example

Suppose Currency A pays 5% and Currency B pays 0.5%. Buying A against B earns roughly the 4.5% gap a year on the position size, minus the broker's markup. With leverage, the return on your margin is larger, but so is the loss if A falls against B.

A 3% fall in the exchange rate would wipe out most of a year's interest in one move, which is why carry traders watch price risk more closely than the interest they earn.

Why carry trades unwind

Carry trades tend to be popular when markets are calm. When fear rises or a central bank surprises, many traders close at once and the low-yielding currency can jump. The Japanese yen, long a funding currency because of its low rates, rose sharply in August 2024 as carry positions were closed in a hurry.