What is a carry trade in forex?

A carry trade is a forex strategy where a trader borrows a currency with a low interest rate to fund the purchase of a currency with a higher interest rate. The goal is to capture the interest rate differential, often called the positive swap or roll. For example, if a trader sells the Japanese Yen, which historically maintains low interest rates, to buy the Australian Dollar, they earn the difference between the two central bank rates. Brokers pay or charge this interest daily at the end of the trading session. If the position remains open overnight, the trader collects the net interest difference. Leverage often magnifies these returns, but it also increases the potential for significant losses. This strategy carries substantial risk. Currency values fluctuate constantly. If the currency purchased depreciates against the borrowed currency, the capital loss can easily exceed the interest earned. Furthermore, central banks may adjust interest rates at any time, which can quickly turn a profitable carry trade into a losing one. Market volatility often triggers sharp reversals that force traders to exit positions at unfavorable prices. Trading involves significant risk of loss, and carry trades are no exception to this reality.