40% Off Signals

Understanding the Carry Trade in Forex Markets

Fundamental Analysis Course
The carry trade is a notable strategy in the foreign exchange (forex) market that has been widely used by traders and institutions, especially during the 2000s and early 2010s. Though less popular in recent years due to shifting economic conditions and lower interest rates globally, it remains a valuable concept for traders who want to enhance returns through strategic currency positioning. This article explains what the carry trade is, why interest rates matter, and how traders can potentially capitalize on this approach in today’s market environment.

What is the Carry Trade?

At its core, the carry trade is a strategy that exploits differences in interest rates between two currencies. Since central banks set varying interest rates across countries, some currencies yield higher interest rates while others have low or even negative rates. The carry trade involves borrowing or selling a currency with a relatively low interest rate and using those funds to buy a currency offering a higher interest rate. The trader then earns the interest rate differential as a form of passive income, often referred to as the “carry.”

Example:
Suppose Currency A offers a 5% interest rate, while Currency B offers -1%. By selling Currency B and buying Currency A, a trader earns a 6% interest differential—assuming the exchange rate remains stable or moves in their favor.

Why Interest Rates Matter

Interest rates are a fundamental driver in currency valuation and play a critical role in the carry trade. A higher interest rate generally indicates a currency will attract more investment because holders can earn more yield by holding assets denominated in that currency. Conversely, currencies with low or negative rates discourage investors because they effectively pay to hold that currency.

This relationship is especially important in the forex market where currencies are traded in pairs. The interest rate of each currency in the pair impacts the cost or benefit of holding a position overnight. Brokers often apply a “swap” or rollover rate reflecting this difference, which can be either a debit or credit to a trader’s account.

Automate your fundamental analysis with EdgeFinder

Fundamental analysis is incredibly powerful, but it's a TON of work. Our tools help you to automate the process and find strong trading setups now. Start trading with fundamentals today, and get a discount on your purchase with promo code "READER" at checkout!

Get the edgefinder

Historical Context: The USD/JPY Carry Trade

One of the most famous carry trades historically involved the U.S. dollar (USD) and the Japanese yen (JPY). During the early 2000s to 2010, the U.S. maintained relatively high interest rates (around 5% or higher at times), while Japan’s interest rates were near zero or even negative. Holding U.S. dollars yielded positive interest, whereas holding yen incurred a cost due to negative or negligible yields.

Traders would borrow yen at low cost and convert them into U.S. dollars to take advantage of the higher yield. This trade was widely practiced by large financial institutions, hedge funds, and other investors managing billions of dollars. The resulting interest rate differential made the USD/JPY pair a classic example of the carry trade strategy.

How Does the Carry Trade Work in practice?

Let’s break down the mechanics of a carry trade:
1. Borrow or sell the low-yielding currency (e.g., JPY).
2. Convert it into the higher-yielding currency (e.g., USD).
3. Invest or deposit the proceeds in an interest-bearing asset or hold the currency pair long in a forex position.
4. Earn the interest differential daily via rollover/swap if the position is held overnight.
In forex platforms, this is reflected as either a debit or a credit on the trader’s account, depending on the interest spread between the two currencies and the trade direction.

Why Lot Size Matters So Much

You might have a perfect technical or fundamental setup, but if your position size is too large, a small swing in price can trigger your stop loss—and with it, a disproportionate loss.

Here's what can go wrong with the wrong lot size:
You risk too much and wipe out your account in a few losing trades.
You risk too little, and even a great win doesn’t move your equity much.
You develop emotional attachment to trades due to large exposure.
You hesitate or second-guess your setups, sabotaging your trading psychology.
Mastering lot size gives you control over your downside, which is the first priority for any serious trader.

Trading the Carry Trade: Practical Considerations

While the carry trade can offer passive income through interest, it’s not a substitute for a complete trading strategy. Here’s what traders should keep in mind:


Technical Analysis Still Matters
Use charts, indicators, and price action strategies to identify favorable entries and exits. Ideally, the technical setup should align with the direction of the carry advantage. For example, if you’re long a high-interest currency, ensure that pair is technically bullish.

Trend Following and Carry Trade
Carry trades perform best during strong, sustained trends. In such environments, traders can benefit from both price appreciation and the interest differential. Trend-following strategies can help maximize the value of carry over time.

Beware of Carry Trade Unwinding
One major risk in carry trading is unwinding—a rapid reversal when economic or policy changes prompt traders to exit carry positions en masse. This often happens when a central bank unexpectedly cuts interest rates, eroding the carry advantage and sparking volatility.

Example: In 2020, the U.S. dollar’s interest rate dropped sharply, which triggered significant unwinding of carry trades involving the dollar. Unwinding can produce sharp moves in exchange rates, so traders must stay vigilant about central bank announcements and global economic news.

Tools to Monitor Carry Trade Opportunities

Staying informed is key. Traders should monitor:
Central bank policies and rate announcements
Interest rate dashboards or economic calendars
Broker swap rates for real-time rollover information
One particularly helpful tool is the EdgeFinder, which includes a built-in Carry Trade Scanner. This feature automatically compares global interest rates and highlights currency pairs with the most favorable interest rate differentials—helping traders quickly spot potential carry trade setups. Instead of manually tracking rate changes across dozens of central banks, the EdgeFinder does the heavy lifting and presents opportunities in a clear, visual format.
Additionally, using demo accounts is a great way to test how carry trades work and understand how swaps affect profit and loss over time.

Key Takeaways

The carry trade involves borrowing or selling a currency with low interest rates to buy a currency with higher interest rates, profiting from the interest rate differential.
Interest rates are a fundamental driver of currency value and determine the daily swap (rollover) payments in forex trading.
Historically, the USD/JPY pair was a popular carry trade due to the large interest rate gap between the U.S. dollar and Japanese yen.
Although global interest rates are lower today, opportunities still exist, especially involving emerging market currencies versus developed markets.
Successful carry trading requires combining interest rate differentials with technical analysis and trend following.
Traders should regularly monitor interest rate data and central bank policies to identify and manage carry trade opportunities effectively.

Free Telegram

Join free telegram for analysis, trade ideas, & trading resources!

Join telegram

Related Videos

How to do the Carry Trade: Powerful Forex Trading Strategy!

Find your trading edge

Take the guesswork out of trading with the EdgeFinder.
View Discounts>>

access now

Continue learning fundamental analysis:

Back to course home

  • Monetary Policy / Tracking Central Banks

    Tracking what the federal banks do and plan to do is essential in a currency’s strength. In this lesson, we cover:
    what is monetary policy?
    What is hawkishness?
    What is dovishness?

    Start lesson

  • Retail Sentiment vs Smart Money

    Sentiment analysis is fundamental in trading analytics. Most investors look to others to see what they’re investing in before they start investing.
    What is a retail trader?
    What is "smart money"?
    How to Trade Retail and Smart Money Sentiment

    Start lesson

  • How Geopolitical Risks Affect The Financial Markets

    Geopolitical risks are factors that can affect the way nations interact with each other. These sorts of conflicts influence market sentiment or even a nation’s GDP. Depending on the type of conflict, certain markets can either suffer or prosper.
    Ways of measuring risk
    Impacts on risk-on markets
    Strategies for investors

    Start lesson

  • How to Trade CPI Data like a PRO

    Inflation is a key economic indicator that provides valuable insights into the broader economic landscape. By understanding and interpreting inflation data, traders can make more informed decisions and navigate the markets with greater confidence and success.
    What is inflation?
    what is CPI?
    how to measure inflation
    how to trade inflation

    Start lesson

  • How to Trade the COT Report

    Learn all about candlestick patterns, how to spot them, and how to trade them!
    What is the COT Report?
    Commercials vs. non-commercials
    The EdgeFinder and COT data
    cons of COT data
    how to use COT data in your trading

    Start lesson

Home
Edgefinder
StockBox
Signals

LINDEX Company

LINDEX is a leading financial analysis and trading education company dedicated to empowering traders of all levels. Our team combines extensive market knowledge with cutting-edge technology to provide valuable insights and tools for traders worldwide.
Visit our InstagramVisit our TwitterVisit our LinkedInVisit our YouTube channel
2025 All Rights Reserved | LINDEX Company
Leveraged trading in foreign currency contracts or other off-exchange products on margin carries a high level of risk and is not suitable for everyone. You may lose more than you invest. Price and performance data is provided for informational purposes only and is not investment advice. Past performance is not indicative of future results.

There is a significant degree of risk involved in trading securities. With respect to foreign exchange trading, there is considerable risk exposure, including but not limited to, leverage, creditworthiness, limited regulatory protection and market volatility that may substantially affect the price, or liquidity of a currency or currency pair. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when trading in CFDs. You should consider whether you can afford to take the high risk of losing your money.
homesmartphonelaptop-phonechart-barsquestion-circlecross-circle
linkedin facebook pinterest youtube rss twitter instagram facebook-blank rss-blank linkedin-blank pinterest youtube twitter instagram