Holding a long position in a high-yielding currency funded by a short in a low-yielding one to earn the rate differential.
A carry trade is a macro strategy that profits from the interest-rate differential (the 'carry') between two currencies rather than from directional price movement. The trader borrows in a currency with a near-zero or negative interest rate - historically the Japanese yen or Swiss franc - and invests in a higher-yielding currency such as the Australian dollar, New Zealand dollar, or Mexican peso. In spot forex, this carry is realised as positive overnight swap credited nightly to the account.
Carry trades are popular because when conditions are right they generate consistent daily income with relatively low day-to-day volatility. Classic pairs such as AUD/JPY, NZD/JPY, and MXN/JPY have historically attracted large institutional carry positions. The Triennial BIS survey shows that carry flows represent a meaningful fraction of daily forex volume, and the convergence of many institutional traders into the same pairs creates a self-reinforcing trend that can persist for months or years.
The critical caveat is that carry trade unwinding can be sudden and violent. During risk-off episodes - a financial crisis, a geopolitical shock, or an unexpected central bank intervention - investors simultaneously close carry positions to reduce exposure, causing the high-yield currencies to fall sharply against the funding currency. The SNB's removal of the EUR/CHF floor in January 2015 caused CHF-funded carry trades to lose years of accumulated carry in minutes. Carry traders need to size positions to withstand these episodic reversals and should monitor global risk sentiment alongside the interest-rate differential.
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