Understanding Swaps In Forex Trading

Posted by Arif Alexander Ahmad on 29-Mar-2019 00:11:57

Here’s a question: What is a forex swap? If you are like many forex traders just starting out - or even if you have many years under your belt but very little time to accumulate a lot of knowledge about the forex industry - this might be a tougher question than it appears. 

Don’t worry. We’re here to help!

 At Scandinavian Capital Markets, we are committed to building powerful relationships with our clients. We see ourselves as partners in our customer’s success. That means we value transparency and education. We want our clients to understand the market, have a basic understanding of how interest, earnings, and fees are calculated, and why things happen the way they do. As we travel down the road to success together, we will continue to provide insight and help our clients become forex experts.

 Get to Know Your Swap

 So what is a swap and what do you need to know about them? In general terms, a forex swap is an overnight (or rollover) interest earned or paid when a trader holds positions overnight. Most of the time, a trader is required to take delivery of currency purchased within two days of the transaction date. However, if the trader chooses to roll over that position, they can extend that settlement period by one day. The rollover usually includes simultaneously closing the trader’s existing position at the close rate for that day and the re-entering the new opening rate for the next trading day.

 Why Do Swaps Matter?

 Forex traders are interested in making money on changes in exchange rates. That means currency purchases aren’t literal - the trader wants to play the margins to make a profit when that currency’s value alters. Every forex transaction involves borrowing. A trader borrows currency from one country to buy the currency of another country. This borrowing generates interest, either owed or paid.

 Swaps matter because earning or owning currency becomes a strategic decision. To earn interest, a trader may take a long position in a high-yielding currency compared to the currency they used to make the purchase. In the event the borrowed currency outperforms the purchased currency, the trader will owe interest. To avoid paying interest, it might make sense to close at the end of the business day (5pm Eastern Standard). On the other hand, if a currency is performing well - and the trader anticipates that performance will continue - a swap may be the best way to prolong the trade and increase the profit.

 This piece will also contain the history related to swaps, how did swaps come to be (Central Banks history leading up to swaps being within the forex world).

 How Are Swaps Calculated

 Swap fees are incurred when a position is kept open overnight. The forex swap fee is determined by calculating the difference between the two currencies being traded according to whether the trader’s position is long or short. The interest rates between the two currencies in the swap can be negative or positive depending on if the trader is borrowing or lending.

 Generally speaking, rollover rates are calculated by subtracting the quote currency interest rate from the best currency interest rate and dividing that sum by the amount calculated when multiplying the base. A rollover rate can also be called a swap fee; The swap rate, on the other hand, the rate at interest at which one currency is exchanged for another. In other words, a swap rate is the difference between a traded currency pair. interest in another currency – that is, a swap rate is the interest rate differential between the currency pair traded. The rollover rate can also be known as the swap fee.

 A way to see how swap rates and rollover rates work in forex, imagine trading between AUD and JPY currencies, and the JPY carries an annualized lending rate of .25% while the AUD borrowing rate is 1.64%, then you would gain 1.39% per year by holding AUD/JPY in a long position. Holding short, on the other hand, would change the lending/borrowing rates, increasing AUD to 2.74% for example, while decreasing JPY to -.15%, resulting in a decrease of annual swap charges by 2.89%

 It’s true that the swap calculation equation can be complicated. Thankfully, there are many online swap calculators that can help you determine what you might owe in fees. Keep in mind that the interest you gain or pay changes across brokers and is heavily influenced by the timing of your trades. That’s why it’s important to work with a brokerage that provides clear information up front. Check with your broker (or any broker you are considering) and look at their swap rates table. In addition, if you are using the MT4 platform, you can right click on the "Market Watch" section and select "Symbols” to see your broker’s swap rates.

 Finally, it’s important to remember that a trade position held open overnight from Wednesday to Thursday, will be charged triple storage because the swap involves pushing back the value date on the underlying futures contract. In other words, when a position is opened on Wednesday, Friday becomes the effective value date. If a position is kept open overnight from Wednesday to Thursday, then the value date is moved forward three days, skipping the weekend and making Monday the effective value date - so the charge is triple to reflect holding for three days rather than one. Storage is tripled because you are being paid or charged interest for three days instead of just one.

 Scandinavian Capital Markets and Swap Trades

 Scandinavian Capital Markets swap rates are calculated each day at 5 pm Eastern Standard Time / 12 pm MT4 platform time (GMT+2). Any trade that has been opened before 5pm and held open past this time will be subject to swap rates. Swap rates are tripled on Wednesday at 4.59 pm to account for weekends. Please note that swap rates vary by pair and are updated frequently as market movement causes swaps to adjust. It is important for traders to familiarize themselves with where to locate the current swap charges for the particular pairs they are trading.

 

Topics: Trading, forex, fx, money manager, trading tools, knowledge, education