What Is a Carry Trade

Two rates, and the gap between them

Every currency has an interest rate set by its central bank. Say, as an example, the pound pays 4 per cent a year and the dollar 3.5. Holding pounds bought with dollars means earning the one and owing the other, and the difference, half a per cent a year here, is the carry. A carry trade is holding the currency with the higher rate against the one with the lower, for that difference. On a trading account it arrives a night at a time as swap — the nightly credit or charge on a trade left open — less the broker's own cut. The rates are an example; each currency's real rate changes with its central bank.

A dripping tap into a jar

Picture a dripping tap over a jar. The carry is the drip: one drop a night, the swap, every night the trade is open, steady and small. The jar is what has been earned so far, and it fills slowly. The exchange rate is the jar being knocked. One bad week on the price can spill a year of drips, and one good week can fill the jar more than the tap ever could. The carry is a certain small thing on top of an uncertain large one, and that is the whole shape of the trade.

This paper is locked