# 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. Source: https://learn.tradelabsai.com/strategies/carry-trading/ Track: Strategies and Styles · Level: Advanced · Updated: 2026-10-03 Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice. Cite as: TradeLabs Learn, "Carry Trading", https://learn.tradelabsai.com/strategies/carry-trading/ A carry trade earns money simply from holding a position, as long as prices stay roughly where they are. The classic example is borrowing in a currency with low interest rates and investing in a currency with high interest rates, pocketing the difference. The same idea exists in bonds, commodities, equities and crypto: any time an asset pays more to hold than it costs to finance, it offers positive carry. Carry strategies have produced positive average returns over long periods, but they are known for sudden, painful crashes. ## What carry means Carry is the return you would earn on a position if prices did not change. It can come from: | Market | Source of carry | Lesson | |---|---|---| | Currencies | Interest rate differential between two currencies | [Carry Trades in Forex](https://learn.tradelabsai.com/forex/carry-trades-in-forex/) | | Bonds | Yield above funding cost, plus rolling down the yield curve | [Yield Curves](https://learn.tradelabsai.com/bonds-credit/yield-curves/) | | Commodities | Roll yield in backwardated futures | [Roll Yield](https://learn.tradelabsai.com/futures/roll-yield/) | | Equities | Dividend yield above financing cost | [Free Cash Flow Yield and Dividend Yield](https://learn.tradelabsai.com/fundamentals/dividend-yield/) | | Crypto perpetuals | Funding payments received | [Funding Rates](https://learn.tradelabsai.com/crypto/funding-rates/) | | Options | Selling volatility premium | [Theta Harvesting](https://learn.tradelabsai.com/options/theta-harvesting/) | ## How an FX carry trade works **Example: Yen funded carry** A trader borrows Japanese yen at an interest rate of 0.5% and converts it to US dollars to earn 5.0%. The rate differential is 4.5% a year. On a $100,000 position, that is about $4,500 a year, or roughly $12 a day, paid through overnight swap or rollover. If USD/JPY stays flat, the trader earns the carry. But if the yen strengthens 5% against the dollar, the currency loss of $5,000 wipes out more than a year of carry. With 10 to 1 leverage, the same 5% move would cost half of the trader's margin. See [Rollover and Swap in Forex](https://learn.tradelabsai.com/forex/rollover-and-swap-in-forex/) and [Leverage and Margin in Forex](https://learn.tradelabsai.com/forex/leverage-and-margin-in-forex/). ## Why carry earns a return Economic theory, specifically uncovered interest rate parity, says high yielding currencies should depreciate by the rate differential, cancelling the carry. In practice, they often have not, on average, which is called the forward premium puzzle. Explanations include: - **Crash risk premium:** carry traders are paid for accepting occasional large losses. - **Liquidity provision:** carry investors provide funding that others need. - **Slow capital:** not enough arbitrage capital to close the gap fully. See [Covered and Uncovered Interest Parity](https://learn.tradelabsai.com/forex/interest-rate-parity/) and [Carry Factor](https://learn.tradelabsai.com/research/carry-factor/). ## The carry crash pattern Carry is often described as "picking up pennies in front of a steamroller". Returns tend to be steady most of the time and then fall sharply during market stress, when investors rush to close leveraged positions and funding currencies such as the yen rally. - **October 2008:** as the financial crisis deepened, the yen surged against high yielding currencies such as the Australian dollar, and carry trades suffered heavy losses within weeks. - **August 2024:** after the Bank of Japan raised rates and US data weakened, a rapid unwinding of yen funded positions coincided with a sharp jump in the yen and a sell off in global stocks. This negative skew means carry returns have fat left tails. See [Skewness and Kurtosis](https://learn.tradelabsai.com/math/skewness-and-kurtosis/). ## Managing carry trades 1. **Use modest leverage** that can survive a sharp move against you. See [Position Sizing](https://learn.tradelabsai.com/risk/position-sizing/). 2. **Diversify across many carry pairs or markets** rather than one big position. 3. **Combine carry with trend or momentum** filters, which can cut exposure when carry trades start to unwind. See [Trend Following](https://learn.tradelabsai.com/strategies/trend-following/). 4. **Watch volatility:** carry tends to do worst when volatility spikes. Some traders reduce size when implied volatility rises. See [Implied Volatility (IV)](https://learn.tradelabsai.com/volatility/implied-volatility/). 5. **Watch central bank policy:** carry depends on rate differentials, which change with monetary policy. See [Central Banks Explained](https://learn.tradelabsai.com/macro/central-banks-explained/). ## Common mistakes - **Focusing on yield and ignoring price risk.** - **Using too much leverage** because daily returns look smooth. - **Concentrating in one funding currency or one trade.** - **Assuming past calm will continue.** See [Recency Bias](https://learn.tradelabsai.com/psychology/recency-bias/). ## Frequently asked questions ### What is a carry trade? A strategy that holds a higher yielding asset funded by a lower yielding one, earning the difference as long as prices stay stable. ### Why are carry trades risky? Price moves can wipe out months of income quickly, and carry trades tend to suffer sharp losses together during market stress. ### What is the yen carry trade? Borrowing in Japanese yen, which has had very low interest rates, to invest in higher yielding currencies or assets. Next, learn how firms earn the bid ask spread in [Market Making](https://learn.tradelabsai.com/strategies/market-making/). ## Continue learning - Next lesson: [Market Making](https://learn.tradelabsai.com/strategies/market-making/) - Previous lesson: [Arbitrage Strategies](https://learn.tradelabsai.com/strategies/arbitrage-strategies/) - Related: [Arbitrage Strategies](https://learn.tradelabsai.com/strategies/arbitrage-strategies/): Arbitrage strategies try to profit from price gaps between the same or linked assets. Learn the main types, worked examples and why arbitrage is rarely riskless. - Related: [Carry Trades in Forex](https://learn.tradelabsai.com/forex/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. - 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 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: [Roll Yield](https://learn.tradelabsai.com/futures/roll-yield/): Roll yield is the return from futures converging toward spot as they near expiry. Learn how contango and backwardation drive it and how to estimate it. - 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.