Not many people know what the ‘Forex Swap’ is and how it can either cost you money or indeed make you money. It’s important to know that the swap can affect your account especially if you hold trades for long periods.
You might think you know all the costs involved in Forex trading, but do you really?
Also called the carry trade or the rollover fee could be a significant expense on your trading.
Before we get started, we also prepare a video on our ForexSignals TV YouTube channel about Forex Swap and the cost behind Trading Forex:
It doesn’t matter what trading entity you’re trading or what financial market you’re looking at, there’s always going to be an associated cost to trading.
What are the main costs of Forex?
The Forex market has three main costs to consider: the broker commission, the spread and the swap.
The broker commission is a fee charged by the broker to facilitate trading.
The spread is the difference between the buying price and the selling price. This spread could increase depending on what currency pair you’re trading.
The majors or anything against the USD currency spread is normally quite tight. And of course, some of the exotic pairs, (e.g Eur/HK$) got a 4 pip spread. The non so active trading currency pairs will have a wider spread. And this is something worth considering when deciding what currency pairs to trade.
Swap is also called the rollover charge and basically, it’s a fee that your broker charges for holding a position overnight. Why? Because the Forex market is open 24 hours a day.
Every 24 hours, brokers close a daily candle and open up a new candle. That’s why you get the daily candles.
Usually, traders use the 5:00 PM, New York close, but every broker can vary this by a couple of hours.
If you are holding a trade position overnight through that 5:00 PM New York close, potentially you’ll get charged a fee for that privilege. In certain circumstances, you may actually receive payment for holding that position overnight.
How interest rates affect the swap?
The first reason why a particular currency pair moves up or down is because of interest rates. Interest rates define how much it costs to borrow money and how much you get back if you deposit money in a savings account.
The interest rates are determined by inflation, employment and other factors. This is why you should always look at the fundamental news throughout the week so you can gauge where the central banks’ interest rates will be in the future.
When we’re trading the Forex market using leverage, which is basically a loan from the broker, we receive interest on the currency that we bought, but we have to pay interest on the currency that we sold. If we buy a currency that has a higher level of interest than the one we sold, it means we get paid. This phenomenon is called a positive swap.
On the other hand, if you buy a currency that has a lower interest than the one you sold, this means you’ll have to pay interest, and this is known as a negative swap.
Let’s say you’re trading the AUD/EUR, which is a long trade. It means you’re buying the Australian dollar and then selling the Euro. In this example, you’d receive interest of 0.25 on the Australian dollars and you’d pay zero interest on the Euros that you have sold. The swap is determined by the differential in the level of interest rates and this one is classified as a positive swap. It means you actually receive money by holding that position overnight through that 5:00 PM New York candle.
How do you work out the exact cost?
Most of the broker platforms can provide a calculator to work out the cost of carrying your position overnight.
Let’s assume that you’re taking a long term position, perhaps the GBP/JPY. Your swap charge for holding a position overnight is going to be $2 per one standard contract.
Doesn’t say very much, does it? But if you hold that position for a year, that will be over $700 just for holding that position.
Quick Summary about the swap:
- Swap is the interest credit or debit for holding a Forex trade overnight
- Buying a currency with a higher interest rate than the short currency is a positive swap which means you earn money overnight
- Buying a currency with a lower interest rate than the short currency is negative swap-you pay money overnight
- The interest rates change daily with the interbank market
- Wednesday is a triple swap because of three-day settlement
As always if you liked this blog, leave a comment below. Until next time happy trading and good luck! I hope to see you in the Trading Room.