What Is a Carry Trade in Forex?

As traders deepen their understanding of the foreign exchange market, they inevitably encounter a growing set of strategies designed to exploit different market mechanics. One of the oldest and most widely used of these approaches is the forex carry trade.

A carry trade focuses less on short-term price movements and more on macroeconomic fundamentals—specifically, the difference in interest rates between two currencies. When executed correctly, a carry trade can generate returns from both interest income and favorable exchange rate movements.

How a Forex Carry Trade Works

At its core, a carry trade involves borrowing a currency with a relatively low interest rate and using those funds to buy a currency with a higher interest rate. In forex markets, this is done by going long one currency pair and implicitly shorting the funding currency.

For example, if a trader buys AUD/JPY, the position effectively means borrowing Japanese yen (traditionally a low-yield currency) to purchase Australian dollars (historically higher yielding). The trader earns interest on the Australian dollar position while paying interest on the borrowed yen.

The net difference between these two interest rates is known as the carry. When the yield on the purchased currency exceeds the cost of the borrowed currency, the position generates a positive carry.

Why Carry Trading Is Popular

Carry trading remains popular because forex markets make interest rate differentials unusually accessible. Unlike bond or money markets, currencies are always traded in pairs, allowing traders to directly express a view on relative interest rates.

Another major factor is leverage. Forex brokers typically allow traders to control large nominal positions with relatively small amounts of capital. Even modest interest differentials can therefore translate into meaningful returns—though this same leverage also magnifies risk.

Common Currency Pairs Used in Carry Trades

Carry traders generally look for a combination of low-yield funding currencies and higher-yield target currencies with relatively stable macroeconomic profiles.

• Funding currencies: Japanese yen (JPY) and Swiss franc (CHF) have historically been popular due to prolonged low interest rate environments.
• Target currencies: Australian dollar (AUD) and New Zealand dollar (NZD) are frequently used when their domestic interest rates exceed those of funding currencies.

While emerging market currencies may offer higher yields, they also introduce significantly higher volatility, political risk, and liquidity constraints, making them less suitable for conservative carry strategies.

Benefits of a Carry Trade Strategy

One of the key advantages of carry trading is that it can generate returns even in relatively range-bound markets. As long as exchange rates remain stable and interest rate differentials persist, traders may earn interest income over time.

Carry trades are therefore often used as medium- to long-term positions rather than short-term speculative trades. When combined with favorable currency appreciation, total returns can exceed those from interest income alone.

Key Risks and Considerations

Despite its reputation as a lower-risk strategy, carry trading is not risk-free. Exchange rate movements can quickly overwhelm months of accumulated interest income if a funding currency strengthens sharply.

Carry trades are particularly vulnerable during periods of market stress, when investors rapidly unwind risk positions and move capital back into perceived safe-haven currencies. This phenomenon, often referred to as a “carry trade unwind,” can produce sudden and severe losses.

Monetary policy changes also pose a significant risk. Central banks can alter interest rates unexpectedly, eroding or reversing the interest differential that underpins the trade. Traders must therefore monitor economic data, inflation trends, and central bank guidance closely.

Is Carry Trading Right for You?

Carry trading is best suited to traders who understand macroeconomic dynamics, risk management, and position sizing. It favors patience, disciplined leverage use, and a willingness to hold positions through extended market cycles.

When used responsibly, carry trades can complement other forex strategies by providing income-oriented exposure. However, without proper risk controls, the same strategy can produce outsized losses during volatile market conditions.