Carry and Rate Differentials

Some positions pay you to hold them. Borrow a currency with a low interest rate, hold one with a high rate, and the difference lands in your account every night. It is the oldest trade in the market, it works for years at a time, and it ends faster than it built — which is the only part most people remember.

Carry as a rate differential

Every forex position is simultaneously long one currency and short another. Holding it overnight means earning interest on the one you are long and paying it on the one you are short.

On one standard lot of EUR/USD at 1.0800 — a notional of $108,000:

At 0.1 lots a 3% differential is about $0.89 a night, and at 0.01 lots about 9 cents. Two things follow from that: carry is proportional to notional rather than to skill, and at retail sizes it is usually immaterial unless the position is both large and held for months.

Swap as the retail form of it

As a retail trader you do not receive the interbank differential. You receive your broker's swap — the differential, adjusted by a markup in the broker's favour on both sides.

• Positive swap is smaller than theory says. The markup comes out of what you are paid.
• Negative swap is larger than theory says. The markup is added to what you pay.
• Both directions can be negative. On some pairs at some brokers, long and short both pay — which is the markup exceeding the differential.
• It is applied at the daily rollover, and Wednesday carries triple to cover the weekend value date.

Track 2's lesson 6 gave the way to measure it rather than assume it: hold 0.01 lots through one rollover and read the charge off the statement. That is worth doing before any strategy that depends on carry, because the difference between brokers on the same pair can exceed the differential itself.

Swap-free accounts

Accounts offered without swap, usually for religious reasons, substitute a fixed administration fee after a number of days. For a carry trade this removes the entire point; for a short-term trader it can be cheaper. Read what replaces the swap before assuming it is free.

Why the unwind is sharp

The carry trade has a distinctive shape: it pays a small amount very reliably for a long time, then loses a large amount very quickly. That asymmetry is structural, not bad luck.

1. It is crowded. A trade that has worked for two years attracts everyone who noticed, and they are all on the same side.
2. It is leveraged. The carry is small relative to the notional, so the only way to make it meaningful is size — which makes the position fragile to a move against it.
3. Everyone exits through the same door. The exit means buying back the funding currency, and everyone needs to do it at once.
4. The move triggers itself. Covering pushes the funding currency up, which worsens every remaining position, which forces more covering.
5. The carry cannot compensate. Three percent a year is roughly one percent a quarter; a currency can move that much in a morning.

That last line is the whole risk in one sentence. The position collects a rate differential measured in percent per year and carries a price exposure measured in percent per day, and any regime change resolves that mismatch against the holder.

Does carry matter at your timeframe

For most retail traders the honest answer is no, and knowing that saves you from building a strategy on a rounding error.

The last row is where carry actually costs retail traders money. Nobody blows up on a carry unwind at 0.05 lots. Plenty of people run a swing strategy that is quietly paying negative swap every night, never add it up, and conclude the method does not work.

What to actually do

• Check the swap on both directions before trading a pair you intend to hold.
• Add it to the cost side of your expectancy calculation, per night, at your real size.
• Avoid holding a large negative-swap position into Wednesday, which charges triple.
• Never take a trade for the carry alone at retail size. The price risk dwarfs it.