What Are Swaps and How Are They Calculated in Forex Trading? (2024)

“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.

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What Are Swaps and How Are They Calculated in Forex Trading? (2024)

FAQs

What Are Swaps and How Are They Calculated in Forex Trading? ›

A currency swap, or swap, is a foreign exchange transaction in which two parties agree to exchange one currency for another at a future date. The currencies are then exchanged immediately at an exchange rate adjusted to reflect the expected rate of the future date, known as a forward exchange rate

forward exchange rate
The forward exchange rate is the rate at which a commercial bank is willing to commit to exchange one currency for another at some specified future date. The forward exchange rate is a type of forward price.
https://en.wikipedia.org › wiki › Forward_exchange_rate
.

How is swap calculated in forex? ›

Calculating the Rate for Forex Calculating the Rate for Forex
  1. Swap rate = (Contract x [Interest rate differential. + Broker's mark-up] /100) x (Price/Number of. days per year)
  2. Swap Short = (100,000 x [0.75 + 0.25] /100) x (1.2500/365)
  3. Swap Short = USD 3.42.

How to earn swap in forex? ›

How to Make Money in Swaps? Positive swaps are generated by buying a currency (the base currency) with a higher interest rate against a currency with a lower rate (the quote currency). In this instance, the investor generates a profit for holding a position overnight.

How is swap price calculated? ›

A swap is priced by solving for the par swap rate, a fixed rate that sets the present value of all future expected floating cash flows equal to the present value of all future fixed cash flows. The value of a swap at inception is zero (ignoring transaction and counterparty credit costs).

How do you value a forex swap? ›

Market value

The fact that a FX Swap is a combination of a spot and a forward transaction, means that it can be valued. The market value depends on the notional, the levels set in the forward contract (i.e. the exchange rate) and on currency market developments.

How do you avoid swaps in forex? ›

Strategies for Managing Swap Rates

Management of swaps in forex involves several key strategies: Short-term Trading: By closing positions before the end of the trading day, traders can avoid incurring overnight fees altogether. It's a so-called day trading since positions are typically closed by the end of the day.

What causes swap in forex? ›

Foreign exchange swap is the difference in the interest rates of the banks issuing the two currencies, which is credited to or charged from the account when the trading position is kept overnight. The central banks of each country determine the key interest rate.

What is an example of a forex swap? ›

Practical Example

Party A is Canadian and needs EUR. Party B is European and needs CAD. The parties enter into a foreign exchange swap today with a maturity of six months. They agree to swap 1,000,000 EUR, or equivalently 1,500,000 CAD at the spot rate of 1.5 EUR/CAD.

What is the trick to forex trading? ›

One of the most important rules is to trade with the trend: if the market is going up, place a 'buy' trade; and if it's going down, place a 'sell' trade. It's probably not a sensible idea to attempt to pick the top or the base.

How much is the swap fee in forex? ›

Swap Fees
InstrumentShort PositionLong Position
AUDUSD-2.05-7.33
CADCHF-10.082.74
CADJPY-19.24.57
CHFJPY-9.520.49
6 more rows

How to calculate swap for xauusd? ›

XAU/USD has a Long swap of – 11.27. If you bought 2 lots, the swap charged would be 2 x – 11.27 equaling -22.54 USD, this total will be converted to your accounts base currency from USD.

How are swaps determined? ›

In practice one leg is generally fixed while the other is variable, that is determined by an uncertain variable such as a benchmark interest rate, a foreign exchange rate, an index price, or a commodity price. Swaps are primarily over-the-counter contracts between companies or financial institutions.

How are FX swaps priced? ›

In theory, the pricing of FX swaps is pinned down by Covered Interest Parity (CIP) - a renowned no- arbitrage relationship in international finance. CIP states that the rate of return on equivalent domestic and foreign assets should equalize after covering exchange rate fluctuations in the FX swap market.

What is an example of a swap? ›

A swap in the financial world refers to a derivative contract where one party will exchange the value of an asset or cash flows with another. For example, a company that is paying a variable interest rate might swap its interest payments with another company that will then pay a fixed rate to the first company.

How to calculate currency swap? ›

Pricing a currency swap involves solving the appropriate notional amount in one currency, given the notional amount in the other currency, and determining the two fixed interest rates. The currency swap value is zero at the time of initiation.

How is forex exchange calculated? ›

The foreign exchange rate is determined in two main ways: a floating rate or a fixed rate. A floating rate is determined on the global currency markets by supply and demand. As a result, the value of the currency will increase if the demand for it is high. The price of a currency will fall if demand is low.

How do you calculate the number of swaps? ›

In ascending order: In Bubble sort, the largest element moves to the right. So swapping is done, when a smaller element is found on the right side. So to count the number of swaps for an element, just count the number of elements on the right side that are smaller than it.

How is swap calculated in MT4? ›

The Swap calculation on MT4 employs a standard mathematical formula, akin to a secret recipe: Swap = (Pip Value) * (Swap Rate) * (Number of Nights) / 10.

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