With the carry trade explained simply: you hold a currency that pays a higher interest rate while selling, or borrowing, one that pays a lower rate, and aim to earn the gap between the two. That gap is the interest rate differential. It sounds like steady income, but exchange rate moves, retail funding costs and sudden unwinds decide whether any of it reaches your account.
Quick answer: what is a carry trade?
A carry trade buys a high-interest currency against a low-interest one to collect the interest rate differential while the position is held. Profit depends on the exchange rate staying stable or rising. Retail traders receive the differential through overnight funding, minus the provider’s markup, which often leaves little or nothing.
How the carry trade works
Every currency has a short-term interest rate, steered by its central bank. If one currency pays a much higher rate than another, holding the higher-yielding one against the lower-yielding one earns the difference each day, at least in theory. Our guide to interest rates and forex explains how central banks set those rates and why markets react to them.
The currency you sell is called the funding currency, and the one you buy is the target currency. The Bank for International Settlements describes carry trades as borrowing in low interest currencies to invest in higher-yielding ones, and notes that low rates made the yen a funding currency of choice in recent years.
Positive and negative carry
Direction matters. Buying the higher-yielding currency is positive carry: in theory you are paid each night. Selling it is negative carry: you pay the differential instead. If you are unsure which currency you are long and short in a pair, our guide on how to trade forex for beginners covers base and quote currencies.
How retail traders actually earn the differential
Banks and funds build carry trades with forwards and swaps. A retail trader using a spread bet or CFD receives or pays the differential through the overnight funding adjustment applied to positions held past the daily cut-off.
Here is the catch. Providers typically add an administration markup to the funding rate, charging it on long and short positions alike. That markup is taken from the credit on the positive-carry side, so a differential that looks generous on a central bank website can shrink to almost nothing, or turn into a charge. Our guide to overnight funding charges explains the formula and where to find your provider’s rates.
| Factor | Headline view | Retail spread bet or CFD |
|---|---|---|
| Interest received | Full rate differential | Differential minus provider markup |
| Entry cost | Very small for banks | Spread paid on entry |
| Exchange rate risk | Full | Full, magnified by leverage |
| Rate changes | Differential can narrow | Credit can turn into a charge |
Worked example: the carry on a £20,000 position
This example is hypothetical, and the rates are made up for illustration, not current figures. Suppose currency A pays 4.5 per cent a year and currency B pays 0.5 per cent, a differential of 4 per cent. We buy A against B with a spread bet worth £20,000 in notional value.
At the full differential, the position would earn £20,000 × 0.04 ÷ 365, about £2.19 a night, or £800 over a year. Now apply a hypothetical provider markup of 2.5 per cent a year. The net credit falls to 1.5 per cent: about £0.82 a night, or £300 a year.
Now compare that with exchange rate risk. A fall of 1.5 per cent in the pair costs £300 on the same £20,000 position, wiping out a full year of net carry. Currency pairs can move that much in a day or two, especially around central bank decisions.
If central bank B then raises its rate to 2.5 per cent, the differential becomes 2 per cent. After the same markup, the credit turns into a charge of 0.5 per cent a year, and the trade now costs money to hold. Leverage adds to the danger: margin trading magnifies losses as well as gains, as our guide to margin and leverage for beginners explains.
Why carry trades unwind sharply
Carry trades tend to do well in calm markets and badly when fear rises. Many traders hold the same positions with borrowed money, so when the funding currency starts to rise, losses quickly exceed months of interest and everyone heads for the exit at once.
The Bank for International Settlements studied one such episode in August 2024. Its bulletin on the market turbulence and carry trade unwind of August 2024 found that FX carry trades were hit hard by deleveraging, and put positions going into the event at roughly ¥40 trillion, about $250 billion. Its Quarterly Review added that the unwinding caused a sharp, if short-lived, rise in funding currencies, mainly the yen.
Theory also warns against easy money. Uncovered interest rate parity suggests the higher-yielding currency should weaken enough to cancel the extra interest. It often does not hold in the short run, which is why carry trades exist, but when it catches up it can do so abruptly.
Common mistakes with the forex carry trade
- Using headline rates: the figure that matters is your provider’s funding rate after markup, not the central bank rate.
- Ignoring the stop: holding a losing carry trade for the interest turns a small loss into a large one.
- Oversizing for the credit: a bigger position earns more carry but magnifies every exchange rate move. Size from your stop with our guide to calculating position size.
- Stacking similar trades: several pairs funded in the same currency are one bet. Our guide to correlation in forex trading shows how to check.
- Missing rate decisions: a surprise cut or hike can change the differential overnight, so keep an eye on the economic calendar.
Frequently asked questions
Can retail traders make money from the carry trade?
It is possible, but the differential retail traders receive is reduced by the provider’s markup and can be close to zero. Any profit usually depends far more on the exchange rate than on the interest.
Why is the yen often used in carry trades?
Japanese interest rates were very low for many years, which made the yen cheap to borrow. The BIS has described it as a funding currency of choice, and the August 2024 unwind showed how quickly the yen can rise when those positions close.
What is a carry trade unwind?
It is when many carry positions close at the same time, usually after a shock. The funding currency rises sharply, losses force more selling, and moves can be far larger than the interest earned.
How long do carry trades last?
They are usually held for weeks or months, since the interest builds up slowly. That makes them closer to a position trading strategy than to day trading, with the risk of holding through major events.
Next steps
Carry is one of several things that move a currency; our guide to building a rules-based risk model shows how to keep any longer-term idea within sensible limits.
Price action and risk come first in our price action trading course, and the basics section is free to start.
This article is for education only and is not financial advice. Trading leveraged products such as CFDs and spread bets carries a high risk of losing money.
