“Swaps are not just another cost of forex trading; they are a key component that can influence your trading strategy and overall profitability.”
Have you ever left a position open overnight, and found that the market moved in your favour, but you still lost money because your swap costs were too high? Or maybe you are considering holding a position overnight, but you are not sure if it’s a good idea because you heard that brokers can charge overnight fees. Well yes, forex swaps are real. But more importantly, they are a critical factor to consider for traders who hold positions for more than a day. To help you understand the risks of incurring swap fees, this article will explain what forex swaps are, how they are calculated, and how you can manage them to help you with your trading strategies.
Jump to a Section
- What Is a Swap in Forex Trading?
- Rollover and Overnight Positions
- How Are Swaps Calculated?
- Example of a Forex Swap
- Managing Swap Rates
- Final Thoughts
What Is a Swap in Forex Trading?
In forex trading, a swap is the interest fee that is either paid or received for holding a currency position overnight. It is determined by the difference in interest rates between the two currencies involved in the trade. For instance, if you are holding a currency with a higher interest rate relative to the currency you are borrowing, you will receive a positive swap. Conversely, if the interest rate on the currency you are holding is lower, you will be charged a negative swap.
Some traders specifically seek to benefit from positive swaps by holding currencies with higher interest rates. Other traders, especially those who hold positions for an extended period, can see negative swaps erode their profits over time. It goes without saying, it’s essential to understand the swap rates offered by your broker and factor them into your trading strategy to avoid unexpected costs.
Let us delve further into the inner workings of swaps.
Rollover and Overnight Positions
Swap fees are charged or credited at the time of “rollover,” which occurs when a forex position is held open past the end of the trading day. Rollover essentially refers to the process of extending the settlement date of an open position to the next trading day. To delay settling the trade, brokers automatically “roll over” the position at the end of each day.
The trading day typically ends at 5 PM EST, which is the designated rollover time. This is when open positions are automatically closed and re-entered at the new open rate. If a trader keeps a position open beyond this point, it is considered an “overnight position,” and the broker applies a swap fee.
How Are Swaps Calculated?
Swaps are calculated based on the interest rate differential between the two currencies in a currency pair. The formula we use to calculate the swap is as follows:
Swap = (One Point / Exchange Rate) * Trade Size * Swap Value in Points
- One Point: The value of a pipette (1/10 of a pip)
- Exchange Rate: The exchange rate of the currency pair you are trading
- Trade Size: The lot size of your trade (eg., 500,000 units if you are trading 5 standard lots)
- Swap Value in Points: Calculated on the basis of the interest rate difference between the two currencies in the currency pair
To view the swap value in points for the currency pair you will be trading, visit our Forex Trading page. You can also use our all-in-one forex calculator to calculate the swap values of your trades with live rates.
Example of a Forex Swap
Let’s go over an example to make things clearer. Suppose you are going short on (selling) EUR/USD at an exchange rate of 1.0895, and you decide to hold your position overnight. You will be trading 5 lots, and the short swap rate of EUR/USD is 0.15.
Summary of Your Trade:
One Point: 0.00001
Account Base Currency: EUR
Currency Pair: EUR/USD
Exchange Rate: 1.0895 (EUR/USD)
Volume in Lots: 5 (One Standard Lot = 100,000 Units)
Short Swap Rate: 0.15
Swap Calculation:
Remember, our formula for calculating the swap was:
Swap = (One Point / Exchange Rate) * Trade Size * Swap Value in Points
Swap = (0.00001 / 1.0895) * (500,000 * 0.15) = €0.69
Since the result is positive, the swap we have calculated here will be credited to your account at the end of the trading day. If it had been negative, it would be taken from your account balance.
Managing Swap Rates
So, how can you minimise the costs of your swap fees, or take advantage of positive swap rates? Here are some key approaches:
1. Closely Monitor Your Broker’s Swap Rates
If you are planning on leaving trades open overnight, you should, first and foremost, research the swap rates of the broker you are trading with. Different brokers offer different swap rates. Ensure you choose a broker with competitive rates, especially if you plan to hold positions overnight frequently.
Additionally, many brokers provide daily updates on the swap rates they offer for different currency pairs. You should always check these before holding a position overnight.
2. Choose Currency Pairs With Positive Swaps
If you buy a currency with a higher interest rate against one with a lower rate, you can earn a positive swap. For example, buying AUD/JPY might result in a positive swap since Australia often has higher interest rates compared to Japan.
What some traders do is follow a strategy called carry trade that involves borrowing a currency with a low-interest rate to fund the purchase of a currency with a high-interest rate. Again, the difference in rates could result in a positive swap.
3. Avoid Holding Positions Overnight
If you want to avoid swap fees altogether, consider closing your positions before the rollover time. You can focus on short-term trading strategies like scalping or day trading instead.
4. Use Swap-Free Accounts
You may want to avoid swaps altogether due to religious reasons. For example, in the Islamic faith, interest is forbidden. As a result, Muslim traders cannot engage in trading activities that involve swaps, and they need specific account options that are tailored to their needs. If you are interested in swap-free trading, you should check whether your broker offers any swap-free or Islamic accounts.
5. Hedge Positions to Offset Swaps
If you are holding positions that result in negative swaps, consider hedging them with other positions that might produce positive swaps or reduce the overall impact.
Final Thoughts
Swaps are not just another cost of forex trading; they are a key component that can influence your trading strategy and overall profitability. Sometimes they come to you in the form of money credited to your account, sometimes they accumulate and eat into your profits. You may choose to avoid them altogether by closing your positions before the end of the trading day. However, if you decide to leave positions open overnight, researching the swap rates of your broker and factoring the swap fee into your trading decisions is a must.
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Frequently Asked Questions
1. Why do brokers charge swaps?
Brokers charge swaps to compensate for the cost of holding a position overnight. The swap fee reflects the difference in interest rates between the two currencies in a forex pair. Brokers adjust these fees to cover their own costs of borrowing or lending money on behalf of traders, and to account for the financial impact of holding positions beyond the trading day.
2. How is the swap fee determined?
The swap fee is determined by the difference in interest rates between the two currencies in a forex pair. When you hold a position overnight, you’re either credited or debited based on whether you’re buying the higher-interest currency or selling it. The fee is also influenced by the broker’s markup and the duration of the position.
3. What is a 3-day swap?
A 3-day swap is a swap fee charged or credited for holding a position overnight through the Wednesday rollover into Thursday. Due to the forex market being open 5 days a week, the interest calculation for a position held from Wednesday to Thursday is typically adjusted to cover the weekend, resulting in a fee that accounts for three days. This adjustment is necessary to reflect the interest payment for Friday through Sunday, when the market is closed.
Read More
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Forex Leverage: Definition, Examples, Risks
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Forex Order Types: Market, Limit and Stop Orders
Long Positions vs. Short Positions in Forex Trading
Setting Stop-Loss (SL) Orders in Forex Trading
