The carry trade strategy is a long-standing and highly effective approach in forex trading that profits from differences in interest rates between currencies. By borrowing in a currency with a low interest rate and investing in one with a high interest rate, traders can earn daily interest payments while also potentially benefiting from price appreciation.

In this article, we explain how the carry trade strategy works and how to apply it successfully across different markets.

What is a Carry Trade in Forex?

A carry trade involves:

• Selling (borrowing) a currency with a low interest rate.
• Buying (investing) in a currency with a high interest rate.

Traders earn the interest rate differential (also called a swap) for holding the position overnight.

If the higher-yielding currency appreciates during the trade, the trader profits both from the interest earned and the currency’s rise in value.

Why the Carry Trade Strategy Works

• Earn Daily Interest: Traders receive swap payments from brokers for holding positions overnight.
• Benefit From Long-Term Trends: Higher-yielding currencies often appreciate when risk appetite is strong.
• Attract Capital Flows: In a risk-on environment, investors seek higher returns in high-yielding currencies.

How to Set Up the Carry Trade Strategy

Here’s how to prepare:

1. Track global interest rates published by major central banks (e.g., Federal Reserve, Reserve Bank of Australia, Bank of Japan).
2. Focus on currency pairs with a large positive interest rate differential such as:
   • AUD/JPY
   • NZD/JPY
   • USD/JPY (historically)
   • GBP/JPY
3. Choose a broker that offers positive swap rates for holding these positions overnight.

Use swap calculators provided by brokers to check expected daily earnings.

How to Trade the Carry Trade Strategy

Here’s a structured approach:

1. Identify the Interest Rate Differential

• Look for pairs where the first currency (base currency) has a significantly higher interest rate than the second (quote currency).
• Example: If Australia’s interest rate is 4% and Japan’s is 0.1%, AUD/JPY becomes a strong carry trade candidate.

Pro Tip: The bigger the gap, the larger the daily interest earned.

2. Confirm Trend Direction

• Buy higher-yielding currencies only if they are trending higher against lower-yielding ones.
• Use technical indicators like moving averages, RSI, or trendlines to confirm.

Only hold carry trades that are aligned with market momentum.

3. Entry Strategy

• Buy Setup: Enter long positions in pairs like AUD/JPY or NZD/JPY when price action confirms an uptrend.
• Sell Setup: Rarely used in carry trading, as selling a high-yielding currency can mean paying swap fees instead of earning them.

4. Stop-loss Placement

• Place stops below key support levels or recent swing lows to protect against adverse moves.
• Allow for some volatility — carry trades often require wider stops.

5. Profit Target

• Target major resistance levels or round numbers.
• Alternatively, use a trailing stop to ride the trend while collecting daily interest.

Carry trades are often held for weeks or months.

6. Risk Management

• Limit overall portfolio exposure to carry trades — high-yielding currencies can be volatile.
• Diversify across different carry pairs if possible.

Protect capital against sharp reversals caused by global risk sentiment shifts.

Best Practices for Carry Trading

• Monitor Risk Sentiment: Carry trades thrive in risk-on environments (e.g., stock markets rising, stable economic conditions).
• Watch Central Bank Policy Changes: Interest rate cuts or hikes can dramatically affect carry trade viability.
• Use Low Leverage: Carry trades are long-term strategies — high leverage increases risk unnecessarily.

When the Carry Trade Strategy Can Fail

• In risk-off markets (e.g., financial crises), investors rush to safe-haven currencies like USD, JPY, or CHF, causing high-yield currencies to fall sharply.
• During sudden central bank policy changes that reduce the interest rate differential.

Quick reactions and stop-losses are crucial if market conditions deteriorate.

Common Mistakes to Avoid

• Ignoring Risk Sentiment: Carry trades can unwind brutally when global risk appetite shifts.
• Holding During Volatile News: Unexpected economic data can spark reversals.
• Overleveraging: Carry trading aims for steady gains — avoid magnifying risks.

Advantages of the Carry Trade Strategy

• Earn Passive Income: Daily interest payments add up over time.
• Benefit From Macro Trends: Ride strong, long-term economic themes.
• Double Profit Potential: Earn from both interest rates and currency appreciation.

Conclusion

The carry trade strategy offers traders a steady, reliable way to profit from global interest rate differentials, especially during stable and optimistic market conditions. By carefully selecting currency pairs, aligning with trend direction, and managing risk prudently, traders can build long-term gains through both price appreciation and swap earnings.

To master professional techniques like the carry trade strategy and build a complete trading plan, explore our expert Trading Courses designed to help you trade smarter, faster, and more successfully.