What is a Carry Trade in Forex?
Quick Answer: A carry trade is a strategy where you borrow a low-interest-rate currency (like JPY) to buy a high-interest-rate currency (like AUD). You profit from the interest rate differential through daily rollover payments, but face risk if the exchange rate moves against you.
Understanding the Carry Trade Strategy
A carry trade is a strategy where you borrow money in a low-interest-rate currency and invest it in a high-interest-rate currency. The profit comes from the interest rate differential - you earn the difference between what you pay and what you receive.
How Carry Trades Work
The mechanics are straightforward:
- Borrow (Sell) low-rate currency: Japanese Yen at 0.1% interest
- Buy high-rate currency: Australian Dollar at 4.35% interest
- Earn the difference: 4.25% annually on the position
- Hold the position: Collect rollover/swap payments daily
The Rollover Mechanism
In forex, positions held overnight incur a rollover (swap) charge or credit:
- Positive carry: You earn daily interest (buying AUD/JPY)
- Negative carry: You pay daily interest (selling AUD/JPY)
- Daily accrual: The interest adds up over time
| Currency Pair | Interest Rate Differential | Typical Use |
|---|---|---|
| AUD/JPY | ~4% | Classic carry pair |
| NZD/JPY | ~5% | High-yield carry |
| USD/JPY | ~5% | Safe carry option |
When Carry Trades Work Best
Ideal market conditions:
- Risk-on environment: Investors comfortable taking risks
- Low volatility: Stable exchange rates protect principal
- Widening rate differentials: High-rate currencies raising rates further
- Strong fundamentals: High-rate currency has economic strength
The Carry Trade Risk
The biggest danger is currency depreciation wiping out your interest gains. If you earn 4% annually on AUD/JPY but the Aussie dollar falls 10% against the Yen, you lose 6% overall. During the 2008 financial crisis, carry trades unwound violently as risk-off sentiment dominated. AUD/JPY crashed 40% in months, devastating carry traders. Never use excessive leverage on carry trades - the slow accumulation of interest can be wiped out by a single sharp move.
Related Terms
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