A carry trade is a forex trading strategy where investors borrow money in a currency with a low interest rate and invest it in a currency with a higher interest rate, profiting from the interest rate differential. This strategy allows traders to earn the “carry” or interest rate spread while potentially benefiting from favorable exchange rate movements.

The success of carry trades depends on stable or favorable currency movements and persistent interest rate differentials between countries. Popular carry trade pairs historically include borrowing in Japanese Yen (low rates) to invest in currencies like Australian Dollar or New Zealand Dollar (higher rates). However, carry trades are vulnerable to sudden market reversals, especially during risk-off periods when investors flee to safe-haven currencies.

Real-world example: A trader borrows Japanese Yen at 0.1% interest rate and converts it to Australian Dollars earning 4.5%, capturing a 4.4% annual carry while hoping AUD doesn’t weaken against JPY.