Carry Trade

A carry trade is a position structured to harvest the interest-rate differential between two currencies, by holding (long) the higher-yielding currency funded by (short) the lower-yielding one and collecting positive swap or rollover over time. Historically popular in low-volatility, stable-rate environments, it can produce steady income while conditions are calm. The critical risk is that the position is still fully exposed to exchange-rate movement and, because it is leveraged, to amplified losses; carry trades are known for unwinding violently when sentiment shifts, wiping out accumulated interest quickly. Negative swap on the opposite side, changing central-bank policy, and liquidity stress all add to the hazard. It is best understood as a leveraged directional bet that happens to pay interest — not as a safe yield product.

In plain English — A carry trade aims to earn the interest-rate difference between two currencies by being long the higher-yielding one and short the lower-yielding one, collecting positive swap each night the position is held. The appeal is income that accrues just for holding. The danger is that exchange-rate moves can dwarf the interest collected: a sharp adverse move in the pair can erase months of carry in a single session. It is an income idea wrapped around real directional risk, not a free yield.

A trader goes long a pair where the bought currency pays a higher interest rate, earning a positive swap each night. If the pair then drops sharply, the price loss can far exceed all the swap income collected.