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Carry
        trading involves borrowing a low yielding currency and buying a high yielding
        one in order to profit from the interest rate differential. You may have
        noticed when trading CFDs on forex that you get charged overnight swap fees at
        the rollover time (which is at the end of the trading day). Those swap fees are
        calculated on the interest rates involving the two currencies in the pair you
        are trading plus other commissions and costs of the broker.


         
   

For
        example, if you short USD/MXN you are credited interest and therefore you
        profit not only from the trade going in your favour but also from pocketing the
        interest from the broker every day. This is an example of a positive carry
        trade. On the other hand, if you were to go long USD/MXN and hold it more than
        one day, then you would be debited an interest from the broker, and this would
        be called a negative carry trade.


         
   

Back
        in 2020 with all the stimulus from governments and central banks that made the
        market expect an economic recovery and a following growth, the carry trades
        involving EM (emerging markets) currencies were absolutely the best ones in the
        FX space. Below you can see a daily chart of USD/MXN that spiked hard during
        February/March 2020 and then started a year long decline.


         
   




   







         
   

One
        of the most famous funding currencies has been the JPY and the carry trades
        involving it amounted to an estimated 1 trillion dollars back in 2007 before
        getting unwound as the Global Financial Crisis (GFC) hit.


         
   

Carry
        trades are generally taken when there's a risk propensity in the markets. In
        fact, when there's a risk on sentiment you will generally see the funding
        currencies involving carry trades perform badly as they are sold against high
        yielding currencies. On the other hand, if there's risk off sentiment you will
        witness what is called "unwind" and the funding currencies are bought back
        gaining in value.


         
   

This
        article was written by Giuseppe Dellamotta.