Forex · Pro · 4 min

The carry trade

You can explain how a carry trade earns the interest rate gap, why it is exposed to sudden currency reversals, and what the August 2024 unwind showed.

Coins and a steamroller

Borrow money where interest is low, invest it where interest is high, and collect the difference every night. It sounds like one of the most reasonable trades in finance, and for long stretches it works.

Traders have a darker description for it: picking up coins in front of a steamroller. This lesson explains both halves of that picture, using a real episode from 2024 described by the BIS.

Slow gains, fast losses

In a carry trade, a trader borrows a currency with a low interest rate and invests in one with a higher rate. In leveraged forex, this is simply a long position in the high-rate currency against the low-rate one, held over many nights. As the lesson on swaps explained, such a position earns the rate gap, minus the broker's markup.

The income is small but steady. The risk is large but rare:

Currency reversals. If the low-rate currency rises against the high-rate one, the trade loses on the exchange rate. A move of 10% costs more than two years of a 4% rate gap.
Crowding. Carry trades are popular, so many investors hold similar positions. When they all try to exit, the funding currency jumps.
Leverage. Margin calls force traders to close at the same time, which pushes the funding currency higher still.

The BIS studied what happened in summer 2024. After years of a weak yen, its trend reversed in July. In early August, deleveraging and rising margin requirements amplified the moves. The BIS found that carry trades, especially those funded in yen, were hit hardest. On 5 August, Japan's TOPIX index fell 12% in a single day. Markets then stabilized quickly, but the losses for many carry positions were already locked in.

Aug 2024: the unwind

A simplified, fictional carry trader in early 2024:

borrows yen at close to zero interest and holds a currency yielding about 5%,
uses leverage, earning a few dollars of swap every night,
watches the account grow slowly for months.

In this simplified example, the yen rises about 10% within a few weeks in late July and early August. At 10:1 leverage, a 10% move against the position wipes out the margin entirely. The swaps earned in those months covered only a small fraction.

Common mistakes

Seeing the swap as free income. It is payment for currency risk.
Using high leverage on carry trades. Small reversals become large losses.
Ignoring crowding. Popular trades unwind together.
Assuming calm lasts. Years of gains can disappear in weeks.

The takeaway

A carry trade borrows a low-rate currency to hold a high-rate one. It earns slowly while calm lasts, and can lose fast when the low-rate currency jumps.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the side that can wipe out years of carry income quickly.

Tap the chart.

A 10% move against the position costs more than two years of a 4% rate gap.
2Which currencies were hit hardest in the August 2024 turbulence, according to the BIS?

The BIS found yen-funded carry trades were especially hard hit as the yen rose.
3Why does leverage make carry trades especially fragile?

Forced closing means buying back the funding currency, which pushes it higher and causes more losses.
4What does a carry trader typically borrow?

The trader borrows cheaply and invests where interest is higher, earning the gap.

of 4 correct.