Carry Trade
A carry trade borrows in a low-interest-rate currency and invests in a higher-yielding one, earning the difference unless exchange rates move against it.
A carry trade borrows where money is cheap and invests where it pays more. In currencies that means being short a low-interest-rate currency and long a higher-yielding one. The interest gap is earned slowly, but an exchange rate move can wipe it out quickly.
- Category
- Trading Strategies
- Reading time
- 3 min
- Also called
- Currency carry trade, FX carry trade, Interest rate carry
- Updated
The carry trade in plain words
A carry trade borrows something cheap to hold and invests in something similar that pays more, earning the difference.1
Research published by NBER documents that carry traders are subject to crash risk.2
Research shows moves between high- and low-yielding currencies are lopsided: steady small gains punctuated by sudden sharp losses.2
How a carry trade is built
Compare rates
Find two currencies with a wide Interest Rate gap.
Check policy
Watch each Central Bank for signs of rate changes.
Go long the higher yielder
Buy the higher-rate currency against the lower-rate one.
Size carefully
Limit Leverage so a sharp move does not wipe out the account.
Plan the exit
Watch for unwinds, which tend to hit when risk appetite and funding dry up.2
Check the rules
Leverage limits and overnight financing rules differ by country and broker.
Worked examples
Example 1 — Steady carry
Carry earnedA hypothetical trader earns a 4% yearly rate gap while the exchange rate stays flat.
| Interest gap | +4% a year |
| Currency move | 0% |
With a stable exchange rate, the trade earns the differential as intended.1
Example 2 — Sudden unwind
CrashA hypothetical high-yield currency falls 10% in a week as markets turn risk-averse.
| Interest earned | +1% |
| Currency move | −10% |
Carry traders are subject to crash risk, and one move erased many months of carry.2
Example 3 — Leverage cut
Damage limitedA hypothetical trader halves leverage after volatility rises.
| Leverage | 10:1 → 5:1 |
| Drawdown in the drop | Smaller |
The unwind came as risk appetite and funding shrank, and the lower leverage kept the damage manageable.2
Carry trade vs directional trading
| Aspect | Carry trade | Directional trading |
|---|---|---|
| Main return | Interest rate gap | Price movement |
| Holding period | Weeks to months | Any |
| Main risk | Sudden currency crashes | Wrong direction |
| Return profile | Small steady gains, rare big losses | Varies with each trade |
Where carry trades appear
Currency markets
The classic case uses an Interest Rate gap.
Policy shifts
Reacting to Central Bank and Federal Open Market Committee decisions.
Risk sentiment
Carry tends to suffer when Fear and Greed turns to fear.
Portfolio mix
Watching Correlation between carry positions.
Advantages and disadvantages
Advantages
- Earns income while waiting.
- Clear logic based on rate gaps.
- Can work for long periods in calm markets.
- Easy to monitor rate changes.
Disadvantages
- Rare but sharp crashes.
- Usually needs leverage.
- Rate gaps can close quickly.
- Many traders crowd the same trades.
Going deeper
Read as far as you need. Each level builds on the one before it.
What it is
Beginner
The idea is to fund cheaply and invest at a higher rate, pocketing the gap for as long as it lasts.1
Crash risk
Intermediate
Returns are negatively skewed: most of the time the trade earns, but its rare losses are large.2
Why crashes happen
Advanced
Those losses come from crowded positions unwinding at once, typically when risk appetite and funding liquidity fall.2
Common mistakes
Too much leverage
One sharp move can wipe out months of carry.
Ignoring rate changes
A rate cut can end the trade.
Crowded positions
Everyone exits at once.
No stop plan
Carry losses can be fast.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- A carry trade borrows low and invests high.
- It earns the interest rate gap.
- Exchange rate moves can wipe out the gain.
- Carry returns are negatively skewed.
- Leverage rules differ by country.
Frequently asked questions
Is carry trading only for currencies?
Why do carry trades crash?
Do I earn interest on every broker?
Further learning
- Interest Rate
The source of carry.
- Central Bank
Who sets the rates.
- Leverage
Why carry can blow up.
- Risk of Ruin
Judging crash risk.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- U.S. Commodity Futures Trading Commission. CFTC Glossary (opens in a new tab) Checked .
- NBER. Carry Trades and Currency Crashes (Working Paper 14473) (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.