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The key premise of day trading strategies is that all positions must be executed before the market closes. Other traders take a long view. When they leave a position open overnight, they pay or earn a fee known as a Forex swap. It is also referred to as the “rollover rate” or the “overnight interest”. How important is it and does it apply to all strategies? Find out in our guide.
What is FX Swap?
Why “swap”? Because every trade in Forex involves buying and selling currencies. For example, when you sell EUR/USD, you get US dollars in exchange for euros. However, the swap phenomenon only applies to mid-term and long-term financial strategies.
Forex is based on margin. You can use funds from your broker to execute leveraged positions worth more than your balance. When a trade extends to the next day, according to the rules of interbank crediting, you pay or earn interest. This amount is the difference between the two interest rates linked to your FX pair — i.e., the rates set by the central banks in these two countries.
How to Avoid Forex Swap?
If you leave positions exposed overnight and the interest rate for the asset being bought is lower, there is no opportunity to evade this interest/fee. However, you can manage your finances smartly or register a special interest-free type of account. Here are three ways to circumvent the difference.
1. Follow Positive Interest
Trading in the direction of the instrument with the highest rate seems like a no-brainer. Yet, following this strategy, all the time is not advisable. It is worth considering if your technical analysis supports it — i.e., the direction is supported by backtests and forward tests.
2. Trade only Intraday
By closing all of your positions before the end of the trading day (10 p.m. GMT), you will avoid the swap trade altogether. On the downside, such strategies are not suitable for everyone. Scalping is particularly stressful and demanding — it requires dipping in and out of the market frequently with positions lasting minutes or even seconds.
3. Open an Islamic Account
Although these trading accounts are known as Islamic, they are not strictly related to religion. According to Sharia law, Muslims are not allowed to pay any interest on business transactions. Swap-free accounts comply with this requirement, so they are preferable if you plan to open overnight positions frequently.
Swap Cost in Forex
The size of the commission is a variable. It depends on the gap between central bank rates in the countries whose national currencies you are trading. This amount is usually bigger for exotic pairs than for majors.
Secondly, the Forex swap also depends on the conditions under which your broker works with crediting organizations. For example, the difference is always earned or paid daily at a fixed time, which is usually midnight server time. Thirdly, how much you pay or earn will also depend on the day of the week:
- Positions active from Wednesday to Thursday bring triple fees/interest.
- Swaps on trades initiated on Friday night are standard.
This peculiarity may seem counterintuitive, but it stems from the way banks work. On the weekends, transactions are not processed, but the valuation date for positions opened on Wednesday is Friday.
Swap on MetaTrader
Users of the MetaTrader 4 and MetaTrader 5 trading platforms can see this information when they open a position and leave it open after the market closes. This value is shown along with other indicators like opening and closing price, profit, and loss.
In MT4 and MT5, you can access these details from the MarketReview window. Just right-click on the currency pair and select the “Contract specification” option.
Positive and Negative Swap
Your outcome is positive when you earn on your overnight position. This means that the rate on the currency you buy is higher than the one on the currency you sell. If the difference is negligible, you can incur a negative swap by buying or selling.
Example of Positive Swap
Suppose you trade USD/MXN, and the rate for the Mexican peso is higher than that for the US dollar (for example, 6.5% against 0.25%). If you buy the peso (sell the pair), you will gain around 6.25%. If you sell the peso, you will pay a negative swap.
In the context of foreign exchange operations, “negativity” means that you pay a fee instead of earning it. This will happen every time you buy a currency with a lower rate against a currency with a higher rate, as long as you leave the position open overnight and your account is not Islamic.
Example of Negative Swap
Suppose you trade USD/ZAR and open a long overnight position — i.e., buy US dollars in exchange for selling the South African rand. The latter has a higher rate of 5.25%. Thus, the result will be a negative swap in forex trading.
Are Swaps Risk-free?
Some traders open overnight trades on a regular basis as a part of the carry trade strategy. The idea is to hold positions with a positive swap open as long as possible. If the difference between the rate for the instrument being bought is significantly bigger than the rate for the currency being sold, you can make a profit on a daily basis.
However, like any Forex strategy, carry trade is not risk-free. When things go smoothly, you can make money on high-yielding currencies quite consistently. In times of forex market turbulence, you may be out of luck with your FX swap.
Before the crisis of 2008, many traders preferred buying GBP for JPY. At that time, the difference between the two currencies was substantial — 5% vs. 0% for the pound and the yen, respectively. Traders could make a tidy profit every day just by keeping their positions open.
Then, in early 2008, the Bank of England made an abrupt move by slashing its interest rate. This was a game-changer. Trading this pair made no sense anymore.
Changes in rates are not the only risk. Traders with modest deposits should not try profiting from swaps. This strategy is associated with heightened risks due to the volatility of the market and the implications of leverage.
How to Calculate the Cost of the FX Swap?
Every pair in Forex follows the following pattern: base currency / counter currency (aka quote currency).
- To calculate the amount, deduct the interest rate of the base instrument from that of the counter instrument.
- If the base currency has a higher interest rate, the outcome is positive.
- If the opposite is true, the outcome is negative.
Suppose you want to go long on EUR/USD (buy euros for US dollars), and the interest rates are 2% for EUR and 1% for USD. In this case, your result will be positive. By holding this position open overnight, you should gain around 1% (2 % – 1 % = 1 %).
If you go short on the same pair, you will sell Euros to get US dollars in return. In this case, the swap will be negative (-1%).
Understanding swaps is vital for swing traders whose positions remain open for several months in a row. The effects of a two-week position for a pair with a negligible difference in rates will be minimal. Thus, swap-free accounts are the most attractive for long-term traders.