# Carry Trades in Forex > A forex carry trade buys a high yielding currency funded by a low yielding one. Learn how it earns, famous unwinds, funding currencies and how to manage crash risk. Source: https://learn.tradelabsai.com/forex/carry-trades-in-forex/ Track: Forex · Level: Intermediate · Updated: 2026-10-03 Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice. Cite as: TradeLabs Learn, "Carry Trades in Forex", https://learn.tradelabsai.com/forex/carry-trades-in-forex/ A forex carry trade borrows in a currency with low interest rates and invests in a currency with higher rates, earning the difference. For retail traders, this means going long a high yielding currency pair and collecting positive rollover each night. Carry trades have been one of the most persistent sources of return in currency markets, but they are vulnerable to sudden, violent unwinds when markets panic. The general strategy across all asset classes is covered in [Carry Trading](https://learn.tradelabsai.com/strategies/carry-trading/); this lesson focuses on currencies. ## How it works 1. **Choose a funding currency** with low rates, historically the Japanese yen or Swiss franc. 2. **Choose a target currency** with higher rates, such as the US dollar, Mexican peso, Australian dollar or other emerging market currencies at times. 3. **Go long the target against the funding currency,** for example long USD/JPY or long MXN/JPY. 4. **Collect the rate difference** through daily rollover. See [Rollover and Swap in Forex](https://learn.tradelabsai.com/forex/rollover-and-swap-in-forex/). 5. **Hope the exchange rate stays stable or moves in your favour.** ## Return components ``` carry trade return ≈ interest differential + exchange rate change ``` **Example: A yen funded peso carry trade** A trader buys MXN/JPY, holding pesos and owing yen. Suppose Mexican rates are 11% and Japanese rates are 0.25%, a differential of about 10.75%. On a position worth $50,000, that is about $5,375 a year in carry before broker markups. - **If MXN/JPY is flat for a year:** profit about $5,375. - **If the peso falls 6% against the yen:** currency loss $3,000, net profit about $2,375. - **If the peso falls 15%:** currency loss $7,500, net loss about $2,125. The carry is a cushion, but large currency moves overwhelm it. Rates are illustrative. ## Why carry has worked on average According to uncovered interest parity, high yielding currencies should fall by the rate differential, removing any gain. Research, including work by Burnside, Eichenbaum and Rebelo and by Lustig and Verdelhan, has found that this often did not happen: high yield currencies did not depreciate enough on average, leaving a profit. Explanations include compensation for crash risk and for exposure to global downturns. See [Covered and Uncovered Interest Parity](https://learn.tradelabsai.com/forex/interest-rate-parity/) and [Carry Factor](https://learn.tradelabsai.com/research/carry-factor/). ## Carry crashes Carry returns are negatively skewed: steady gains punctuated by sharp losses. Unwinds happen when risk appetite collapses and traders rush to repay funding currencies. - **October 2008:** during the global financial crisis, AUD/JPY fell roughly 40% between August and late October as yen funded carry trades unwound. See [The 2008 Financial Crisis](https://learn.tradelabsai.com/history/the-2008-financial-crisis/). - **January 2015:** the Swiss National Bank removed its franc cap, and the franc surged about 30% against the euro in minutes, devastating short franc positions. See [Central Bank Intervention](https://learn.tradelabsai.com/forex/central-bank-intervention/). - **August 2024:** after the Bank of Japan raised rates and US growth fears rose, the yen jumped sharply. USD/JPY fell from around 162 in July to near 142 in early August, and global markets sold off as yen carry positions unwound. ## Managing carry risk 1. **Keep leverage low.** Carry gains are small relative to potential currency moves. See [Leverage and Margin in Forex](https://learn.tradelabsai.com/forex/leverage-and-margin-in-forex/). 2. **Diversify** across several high and low yielders rather than one pair. 3. **Combine with trend filters:** reduce or exit carry when the high yielder is in a downtrend. See [Trend Following](https://learn.tradelabsai.com/strategies/trend-following/). 4. **Watch volatility:** carry trades tend to suffer when FX volatility rises. Some strategies cut exposure when implied volatility jumps. See [Implied Volatility (IV)](https://learn.tradelabsai.com/volatility/implied-volatility/). 5. **Watch funding currency policy:** a hawkish turn from the Bank of Japan or Swiss National Bank can trigger unwinds. See [The ECB and the BOJ](https://learn.tradelabsai.com/macro/the-ecb-and-the-boj/). 6. **Use options** to cap downside, such as buying puts on the high yielder. See [FX Options](https://learn.tradelabsai.com/forex/fx-options/). ## Positioning data Traders watch the CFTC Commitments of Traders reports for crowded positions in yen and other currency futures. Extreme short yen positioning has often preceded sharp yen rallies. See [Sentiment Data](https://learn.tradelabsai.com/alternative-data/sentiment-data/). ## Common mistakes - **Focusing on the swap and ignoring price risk.** - **Using high leverage** because daily returns look calm. - **Concentrating in one exotic pair** with high political risk. ## Frequently asked questions ### What is a carry trade in forex? A strategy that holds a high interest rate currency funded by a low interest rate currency, earning the rate difference through rollover. ### Why is the yen used for carry trades? Because Japanese interest rates have been very low for decades, making the yen cheap to borrow. ### What causes a carry trade unwind? Sudden risk aversion, rising volatility or changes in central bank policy that push traders to close positions and repay funding currencies, causing sharp moves. Next, learn how governments act directly in currency markets in [Central Bank Intervention](https://learn.tradelabsai.com/forex/central-bank-intervention/). ## Continue learning - Next lesson: [Central Bank Intervention](https://learn.tradelabsai.com/forex/central-bank-intervention/) - Previous lesson: [Interest Rate Differentials](https://learn.tradelabsai.com/forex/interest-rate-differentials/) - Related: [Interest Rate Differentials](https://learn.tradelabsai.com/forex/interest-rate-differentials/): The gap between two countries' interest rates is a major driver of exchange rates. Learn why differentials move currencies, how to track them and their limits. - Related: [Carry Trading](https://learn.tradelabsai.com/strategies/carry-trading/): Carry trading holds higher yielding assets funded by lower yielding ones to earn the difference. Learn how carry works across markets and why carry trades crash. - Related: [Rollover and Swap in Forex](https://learn.tradelabsai.com/forex/rollover-and-swap-in-forex/): Holding a forex position overnight earns or pays interest called rollover or swap. Learn how it is calculated, triple Wednesday, swap free accounts and carry. - Related: [Carry Factor](https://learn.tradelabsai.com/research/carry-factor/): The carry factor buys higher yielding assets and sells lower yielding ones across currencies, bonds, commodities and stocks. Learn how carry is measured. - Related: [Central Bank Intervention](https://learn.tradelabsai.com/forex/central-bank-intervention/): Central banks sometimes buy or sell their own currency to influence its value. Learn how intervention works, famous examples, warning signs and how traders respond.