On an invented price path, the exchange rate drifts quietly for a long time while interest adds up a little each day, then falls in a few days by far more than the interest collected, with one long trade held throughout: one trade is marked, none closed ahead and one closed behind.
A triangle marks where a trade opens and points the way it was taken. A green dot is a trade closed ahead, a red dot one closed behind. The path was invented to show how the approach behaves, including where it goes wrong. It is not market data and it proves nothing.
Also searched ascarry trade strategy · currency carry trade · yen carry trade · positive swap trading · interest rate differential
A description, not a recommendation
This is a description of an approach people use. It is not a recommendation. No approach works in every market, nothing here has been shown to be profitable, and the chart is invented.
The idea
Each currency has an interest rate. Someone who holds a currency with a high rate, paid for by borrowing one with a low rate, receives the difference for as long as the position is open: that difference is the carry. On a leveraged account it arrives as the nightly swap. The trade earns a little every day provided the exchange rate does not move against it by more than the interest collected.
Usually heldMonths · others held about as long
The rule, as people usually state it
As usually stated: buy a currency whose central bank rate is high against one whose rate is low, hold the position, and collect the swap each night. Some versions hold a basket of several high-rate currencies against several low-rate ones to spread the risk. The position is kept while the rate difference remains and markets are calm.
What it needs from a market
- A real, positive interest difference after the firm’s own swap rates are applied. The swap a retail account receives is smaller than the difference between the official rates, and can be negative in both directions.
- A stable or favourable exchange rate.
- Calm markets. The trade is, in effect, a bet that nothing dramatic happens.
What it costs
Almost no trading: one entry and one exit, so one spread. The costs lie elsewhere. The swap actually credited is the interest difference less the firm’s charge. Leverage multiplies the carry and multiplies the exchange-rate risk by the same amount. And the trade ties up margin for months. Economic theory says the high-rate currency should, on average, fall by enough to cancel the interest; the record shows long periods when it did not, ended by short periods when it fell by far more.
When it fails
- In a panic. When markets turn fearful, carry positions are closed together: the high-rate currency falls and the low-rate one rises, fast. In the autumn of 2008, during the financial crisis, the Japanese yen, widely borrowed for these trades, rose sharply against higher-rate currencies as they were unwound.
- When the rate difference narrows or reverses, because a central bank changes its rate.
- When a move of a few days removes the interest of several years. The gains are small and regular; the loss is large and sudden.
The mistakes people make with it
- Looking at the swap and not at the exchange rate, which moves more in a day than the swap pays in a month.
- Using high leverage to make a small yield look large.
- Assuming a long calm period shows the trade is safe. A long calm is what the trade looks like before it unwinds.
- Not checking the actual swap rates, which differ from firm to firm and change.
In the rule bench
The rule bench cannot express a carry trade. It has no interest rates and no swap, and on its invented prices a position held for the interest would earn nothing at all.
Questions people ask
- Is the carry trade profitable?
- Nothing on this page shows that it is. The page describes what people do and why. Published research on trading rules is mixed, results that looked good in one period have often faded in the next, and costs remove much of what remains. The loss figures that regulators require firms to publish show that most retail accounts trading CFDs lose money.
- Why do carry trades unwind so quickly?
- Because many holders have the same position for the same reason. When the exchange rate starts to fall, the loss on a leveraged position soon exceeds the interest earned, holders close, and their selling moves the rate further. The description often used is that the trade goes up by the stairs and down by the lift.
- Is the swap I receive the same as the interest rate difference?
- No. The swap on a retail account is set by the firm from the difference in rates, less its own charge, and it can be negative on both sides of a pair. The figure that applies is the one shown for the instrument on the account, and it changes.
The words on this page
An explanation for study. It is not advice, a recommendation or a forecast. This is a description of an approach people use. It is not a recommendation. No approach works in every market, nothing here has been shown to be profitable, and the chart is invented.