Carry Trade Guide: How It Works and Why It Unwinds

By Rutger Lokin · Updated 17 October 2026

Carry trade guide: a carry trade holds a currency with a higher interest rate against one with a lower rate, and collects the difference for as long as the position is open. The income is small and steady. The risk is that the exchange rate moves against you faster than the interest comes in.

How it works

The low-rate side is the funding currency: the one you borrow or sell. Historically that has often been the Japanese yen or the Swiss franc.
The high-rate side is the target currency: the one you hold, often the Australian or New Zealand dollar.
The gap between their short-term rates is the interest rate differential, and that gap is the carry. It is on Interest rate differential by currency pair for every major pair.

The trade depends on where rates are going, not only where they are. When markets expect the gap to narrow, the case for carry weakens before any rate has changed.

The swap: how the carry reaches your account

In a leveraged FX account, the broker handles the financing. Hold a position past the daily roll, around 5 p.m. New York time at most brokers, and your account is credited or debited the swap, also called rollover.

Hold the higher-yielding currency against the lower-yielding one: you usually receive.
Hold it the other way round: you pay.
Brokers add a markup, so you receive less than the full differential. Where the differential is small, both sides can be negative.

Any position that earns positive swap is carry, strictly speaking. A carry trade is one held mainly for that interest, rather than one where the swap is a side effect of a view on direction.

A worked example

The numbers are invented for easy arithmetic. They are not any pair’s current rates.

The target currency pays 4.5% and the funding currency 0.5%: a gap of 4 points.
On a position of 100,000, that is about 4,000 a year before costs, or 11 a day.
A broker markup of 1 point leaves about 3,000 a year, roughly 8 a day.
The pair falls 5% in one nervous week: a loss of about 5,000, more than a year and a half of swap.
Opened on 10,000 of margin (10:1 leverage), that week costs half of it.

Small, steady income against occasional large price moves: that is carry’s whole risk.

Why carry unwinds fast

Carry tends to do well in calm markets, when exchange rates move little and the interest builds up. It suffers when volatility jumps.

Funding currencies are often safe havens, which investors buy when they are scared. Target currencies pay more because they carry more risk, and tend to fall hardest when sentiment turns. In a panic both legs move against you at once.

Carry is also leveraged and often crowded. A shock forces some holders to cut. They buy back the funding currency and sell the target, which deepens the losses of everyone else and forces more selling.

August 2024 is a recent case. On 31 July the Bank of Japan raised its policy rate to around 0.25% (Bank of Japan statement). A weak US release in early August added to the move. The BIS found that FX carry trades were hit hard by the deleveraging, and put their size going in at a rough ¥40 trillion, about $250 billion (BIS Bulletin 90).

Positioning as an early warning

Crowding is what makes an unwind violent, so the size of the crowd is worth watching. Speculative positioning in currency futures shows part of it: not every speculative position is a carry trade. How the largest traders are positioned in the yen is on the yen’s COT page.

A crowded position does not tell you when an unwind starts, only how much could unwind. Size the position for the drawdown, not for the yield.