The Carry Trade Explained: How It Works and When It Unwinds
The carry trade explained: how holding a high-rate currency against a low-rate one earns swap, why markups eat it and why it unwinds so violently.
A currency pair that pays you a little every night you hold it sounds like the closest thing trading has to a salary. That is the pitch behind the carry trade, and it is only half the story.
Quick answer: A carry trade means borrowing, or selling, a low-interest-rate currency and holding a higher-yielding one to earn the rate difference. Retail traders collect it as positive swap each night. It pays small, steady amounts in calm markets, but when fear rises, carry positions are closed together and the moves can erase years of interest in days.
What is a carry trade?
A carry trade is one of the oldest ideas in currency markets. You borrow money in a currency where interest rates are low, convert it into a currency where rates are higher, and hold it. As long as the exchange rate stays roughly where it is, you keep the difference between the two interest rates. That difference is called the carry, and the gap between the two rates is the interest rate differential.
Large investors do this literally. A fund borrows yen at a low rate, sells them for dollars, and buys US government bonds that pay more. For a retail trader the borrowing is built into the trade itself. When you buy a currency pair, you are in effect holding the first currency (the base) and borrowing the second (the quote) to pay for it. So buying a pair where the base currency pays a higher rate than the quote currency is a carry trade, whether you meant it as one or not.
Take the classic yen version with illustrative rates: 4.0% on the US dollar and 0.5% on the Japanese yen. Buying one standard lot of USD/JPY at 150.00 means holding $100,000 and owing ¥15,000,000. The diagram shows the three steps hidden inside that one click.
The trade has two separate sources of profit and loss. The first is the carry: small, predictable and paid every night. The second is the exchange rate: large, unpredictable and capable of moving many times the size of a year’s carry in a week. A carry trade is a bet that the first will pile up faster than the second can hurt you.
How the carry trade works in forex: swap and the rate gap
Retail traders never see a loan agreement. The carry arrives through the swap, the overnight interest that your broker credits or charges on every position still open at the daily rollover, 5 p.m. New York time. Hold the higher-yielding currency and the swap can be positive; hold the lower-yielding one and you pay. Our full guide to forex swap and rollover explains how it is calculated, why Wednesday usually carries three nights, and how to read swap points on your platform.
The rates themselves come from central banks. The Federal Reserve sets the policy rate behind the dollar, the Bank of Japan sets the rate behind the yen, the Reserve Bank of Australia the rate behind the Australian dollar, and so on. Short-term market rates in each currency follow those policy rates closely, and the interbank cost of rolling a position overnight is built from the gap between them.
The carry changes whenever either central bank moves, and markets start pricing a change well before it happens. Step through the chain below. A hike in the high-yielding currency widens the gap and makes the carry richer; a hike by the funding currency’s central bank narrows it. Switch to a cut to see the reverse.
How a rate decision reaches the currency. The same change in the rate gap also resets the nightly swap on every carry trade in that currency, so the income from a carry position can shrink after a single meeting.
There is a second reason carry trades attract money, beyond the nightly interest. Higher rates tend to draw investment into a currency, which can push its price up over time. Economic theory, under a principle called uncovered interest parity, says the opposite should happen on average: the higher-yielding currency should drift lower by roughly the rate gap, cancelling the carry. Over long stretches it often has not, and that gap between theory and practice is a large part of why the carry trade has stayed popular. The catch is in how the returns arrive. The gains tend to come slowly, a little each week. The losses tend to come in bursts.
The Academy lesson on central banks shows how to read a rate decision, and our guide to how interest rates affect currency prices covers rate expectations and the differential in depth.
Why retail carry trades often lose to swap markups
The figures above are interbank numbers: what a large bank pays or earns to roll a position. Your broker does not pass that through untouched. It takes the interbank rate and subtracts a markup from the side that earns, and adds one to the side that pays. That markup is one of the ways it is paid for holding your position overnight.
With an illustrative markup of 0.5% a year on each side, the 3.5% gap on USD/JPY becomes 3.0% if you are long and a 4.0% charge if you are short. In money, for one lot held for a year, the picture looks like this.
A 0.5% markup takes one-seventh of the carry in this example. That is the gentle case. Markups vary by broker and by pair, and they are rarely published as a percentage, so you have to work them out from the swap figures on your platform. Three things make the squeeze worse for a retail carry trader.
Narrow gaps disappear entirely. If two currencies’ rates are only 1% apart and the markup is 1% on each side, the long side earns nothing and the short side pays 2%. Many pairs that look like carry candidates on a table of central bank rates turn out to pay nothing, or to charge both ways, once the markup is applied.
The rate gap moves against you just when you need it. Carry is richest when the high-yielding central bank has been hiking for a while. That is often late in the cycle, close to the point where it starts cutting, or where the funding currency’s central bank starts raising rates. Japan ended negative rates in March 2024 after eight years below zero, and each later move narrowed the gap that yen carry trades lived on.
The trade is not free to open or close. You pay the spread to get in and again to get out, and spreads on higher-yielding crosses are usually wider than on the major pairs. A position that is opened and closed several times a year can hand a meaningful slice of its carry straight back.
None of this means a positive swap is worthless. It means the number to judge is the swap your platform actually shows, after the markup, measured against the risk you are carrying to earn it. The Academy lesson on the real cost of trading shows how swap sits alongside spread and commission, and our guide to forex trading costs adds them up over a month.
When the carry trade unwinds
A carry trade that works for months can be undone in days. When traders talk about a carry trade unwind, they mean the moment when large numbers of carry positions are closed at the same time: the high-yielding currency is sold and the borrowed funding currency is bought back. Because everyone is heading for the same exit, the moves are fast, and they often overshoot.
The return pattern is so lopsided that traders have a phrase for it: up the stairs, down in the lift.
Why unwinds feed on themselves
An unwind usually starts with a shock: a sharp fall in share prices, a surprise from a central bank, weak economic data, or a sudden rise in fear for reasons that have nothing to do with either currency. That is the link to risk-on and risk-off moods. Carry trades are a bet on calm, so they are among the first positions closed when the mood turns. Toggle the map to see which currencies tend to gain in each mood.
Tap a currency to see why it behaves this way.
Risk-on and risk-off. The high-yielding currencies that carry traders buy, such as AUD and NZD, tend to fall in risk-off, while the low-rate funding currencies, especially the yen, tend to rise as borrowed money is repaid.
Once the first carry traders start closing, the mechanism turns into a loop. Losses trigger stop-loss orders and margin calls. Forced closing means more selling of the high-yielding currency and more buying of the funding currency. That pushes the funding currency higher, which creates fresh losses for everyone still holding the trade.
This is why the yen can rise in a panic even when nothing has happened in Japan, a pattern our guide to safe-haven currencies looks at alongside the dollar and the Swiss franc. Part of the yen’s safe-haven behaviour is simply carry trades being repaid.
Two unwinds worth knowing
Two episodes show the pattern clearly. The details differ, but the shape is the same: a crowded trade, a wide rate gap, a trigger, and a move far larger than the carry it had been earning.
| Autumn 2008 | Summer 2024 | |
|---|---|---|
| Main pair | AUD/JPY | USD/JPY |
| Rate gap before | Australian cash rate around 7%, Japan around 0.5% | US rates above 5%, Japan close to zero |
| Trigger | Global financial crisis and collapsing share prices | Bank of Japan rate rise at the end of July, then a weak US jobs report |
| The move | From above 100 in the summer to below 60 by late October | From near 162 in early July to around 142 on 5 August |
| Knock-on | Higher-yielding currencies fell hard against the yen worldwide | Japan’s Nikkei 225 fell more than 12% in one day, its worst since 1987 |
In 2008 the trade had been popular for years, helped by one of the widest rate gaps among the major economies. When the financial crisis deepened, investors wanted safety rather than yield, and AUD/JPY lost more than a third of its value in a few months. A year of carry at a gap of roughly 6.5 points is worth about 6.5% of the position. The exchange rate took back several years of that in weeks.
In 2024 the gap came under pressure from both sides at once. The Bank of Japan raised rates at the end of July, and a few days later weaker US jobs data pulled expectations for US rates lower. Yen-funded positions in dollars, Mexican pesos and other higher-yielding currencies were closed in a rush. The episode was short, and markets calmed within days, but anyone who was heavily leveraged on the trade did not have days. Our USD/JPY trading guide covers the dollar-yen side of that summer, including Japan’s intervention.
The carry trade and leverage: the real danger
Carry income is tiny relative to the size of the position. Leverage is what makes it look interesting, and leverage is also what makes it dangerous.
In the example above, one lot of USD/JPY earns about $3,000 a year after the markup. That is 3% of the $100,000 position. On a $10,000 account it looks like 30% a year, and that framing is exactly the trap. You do not own $100,000 of dollars; you control it with a fraction of your account set aside as margin, and every yen of movement in the exchange rate is applied to the full $100,000. Regulators in the UK and EU cap retail leverage on major pairs such as USD/JPY at 1:30, so that one lot needs about $3,333 of margin, a third of the account. The cap limits how big a position you can open. It does nothing to make a position of that size suitable for a $10,000 account.
The clearest way to see the imbalance is to measure the carry in pips, the same unit as the exchange-rate risk. On one lot of USD/JPY at 150, a pip is worth ¥1,000, about $6.67.
Each night’s swap is worth a little over one pip. A routine day’s movement in USD/JPY is many times that. So the carry cannot absorb a normal day’s move. The step-by-step chart below shows how that plays out on a single trade.
An illustrative carry trade on USD/JPY weekly candles, not real data. Fourteen weeks of carry and a rising price look comfortable; a four-week unwind wipes out both, and the swap collected along the way barely registers.
Leverage cuts both ways on every trade, but carry trades have a particular habit of luring people into using more of it. The income looks reliable, so it feels safe to add size; the exchange rate drifts up for months, so it feels safe to add again. By the time the unwind arrives, the position is often at its largest. Our guide to leverage in forex and the Academy lesson on leverage and margin explain the arithmetic of margin and position size. Leverage magnifies losses as well as gains, and a positive swap does nothing to change that.
Once a position is sized from a stop and a fixed risk per trade, the carry shrinks to pocket change, and the trade has to justify itself on the exchange rate alone. The Risk Management course’s lesson on risk per trade and our guide to position sizing show how to work out the size for any stop.
How to approach the carry trade as a retail trader
You do not have to avoid positive swap. Holding the side of a pair that pays you is better than holding the side that charges you, all else being equal. The mistake is letting the swap make the decision.
Decide the trade on the exchange rate first. Is there a reason, from your method, to expect the pair to rise? If not, the swap does not create one. If there is, a positive swap is a small tailwind for a trade you would take anyway.
Read the actual swap, not the central bank rates. Open the symbol specification and check both swap figures. Turn them into money per night for your size, and into pips. The markup is in there, and it may leave far less carry than the rate table suggests.
Know what you are betting on. A long position in a higher-yielding currency against a funding currency is a bet that markets stay calm. Several such positions, say long AUD/JPY, long NZD/JPY and long USD/JPY, are one bet on the same mood. Our guide to risk-on vs risk-off explains how to read the mood, and the lesson on correlation risk shows how to cap the total.
Watch both central banks. The carry depends on two rates. A hint that the funding currency’s central bank will raise rates, or that the high-yielder’s will cut, can start an unwind before any rate actually changes.
Respect the gap risk. A stop-loss limits a loss only if the market trades through it. Unwinds often start in thin trading, overnight or at the weekly open, and prices can jump straight past a stop. Smaller positions are the only protection that works in a gap.
The checklist below turns those habits into five ticks before you hold any position for its swap. It saves your progress in your browser.
Before you hold a trade for its carry
0 of 5
Then test your reaction on a morning when the mood turns.
What would you do?
You have held long AUD/JPY for three months, sized correctly with a stop, and collected a steady positive swap. Overnight, stock markets fall sharply on a banking scare and AUD/JPY opens 150 pips lower. Your stop has not been hit, and the swap is still positive. What do you do?
Common mistakes with the carry trade
Choosing a direction for the swap
The swap is a small adjustment to a trade’s result. The exchange rate decides it. A trade taken only because it pays a few dollars a night has no reason to exist when the price turns.
Measuring carry against your margin, not the position
A 3% carry on a position looks like 30% a year on a tenth of its value. That is leverage talking, and it applies equally to the losses. Always measure carry against the full position size, and in pips.
Ignoring the markup and the rate cycle
The carry on your platform is the interbank gap minus the broker’s cut, and it shrinks whenever the gap narrows. Check the real swap before entry and again after each central bank meeting for both currencies.
Treating several carry trades as diversification
Long AUD/JPY, NZD/JPY and USD/JPY are three tickets and one idea. In an unwind they tend to fall together, and their stops can be hit in the same session.
Adding size as the trade grinds higher
Months of steady gains make larger positions feel safe. That is how a carry position ends up at its biggest when the unwind starts. Keep risk per trade fixed, however calm the market looks.
Frequently asked questions
What is a carry trade in simple terms?
A carry trade means borrowing a currency with a low interest rate and holding one with a higher rate, to earn the difference. In retail forex, you do this by buying a pair whose first currency pays more than the second, and you receive the difference, less a broker markup, as a positive swap each night the position stays open.
Is the carry trade profitable for retail traders?
It can earn a positive swap, but that income is small compared with normal exchange-rate moves, and broker markups take a share of it. Over time, the result depends mainly on the exchange rate, not the carry. Carry trades are also exposed to sudden unwinds, which can erase months or years of swap in days.
Why do carry trades unwind so fast?
Because many investors hold the same positions. When a shock hits, losses trigger stops and margin calls, forcing positions to close. Closing means selling the high-yielding currency and buying back the funding currency, which pushes prices further and causes more losses. That self-reinforcing loop makes unwinds much faster than the build-up.
What was the yen carry trade unwind in 2024?
In early August 2024, after the Bank of Japan raised rates and weak US jobs data pulled US rate expectations lower, yen-funded positions were closed in a rush. USD/JPY fell from near 162 in early July to around 142 on 5 August, and Japan's Nikkei 225 fell more than 12% in a single day.
Which currencies are used in carry trades?
Funding currencies are those with low interest rates; for many years the Japanese yen and the Swiss franc played that role. Target currencies are those with higher rates, often the Australian and New Zealand dollars or emerging-market currencies. Which pairs qualify changes as central banks move rates, so check current swap figures rather than old lists.
Is positive swap free money?
No. A positive swap is real income, but it comes with the exchange-rate risk of holding the position, and that risk is far larger than the swap. A position earning $8 a night can lose that amount many times over in a single ordinary day, and much more in an unwind.
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