Investopedia explains Currency Carry Trade
Here's an example of a "yen carry trade": a trader borrows 1,000 yen from a Japanese bank, converts the funds into U.S. dollars and buys a bond for the equivalent amount. Let's assume that the bond pays 4.5% and the Japanese interest rate is set at 0%. The trader stands to make a profit of 4.5% (4.5% - 0%), as long as the exchange rate between the countries does not change. Many professional traders use this trade because the gains can become very large when leverage is taken into consideration. If the trader in our example uses a common leverage factor of 10:1, then she can stand to make a profit of 45%.
The big risk in a carry trade is the uncertainty of exchange rates. Using the example above, if the U.S. dollar was to fall in value relative to the Japanese yen, then the trader would run the risk of losing money. Also, these transactions are generally done with a lot of leverage, so a small movement in exchange rates can result in huge losses unless hedged appropriately.
I think you should get the clear picture now. The impact of carry trade can be very big if the economic experience "earthquake". One of the scenario it happened is back to end of 2008 and early of 2009. During this period, the Japanese unwind the carry trade (convert back USD to Yen) and it shifted the demand curve thus Yen appreciate tremendously. Again, to protect this kind of event, you need to hedge it properly. I am learning another hedging tool: FOREX Options. I need to experience it before sharing with you. At the same time, I feel very comfortable of my return in Forex with my current strategies.
