Discussion Topic: Forex Swap Rates
In this article, we will discuss the Forex Swap Rates. Here we will explain the complex jargon in a very simple way so that you can understand it properly. Here you will learn, what is swap in forex? How forex swap works? When and how much swap fees you will be charged by your broker?
Forex Swap - Defining the Jargon:
Don’t get afraid - just read it! I’m just defining the jargon. I’ll explain everything later, down within this article.
A forex swap is an agreement between two parties to exchange a given amount of foreign exchange currency for an equal amount of another forex currency based on the current spot rate. The two parties will then be bound to give back the original amounts swapped at a later date, at a specific forward rate.
This forward rate locks into the currency exchange rate at which the funds will be swapped in the future, while ignoring any future changes in the interest rates of the respective currencies. This is actually a means of creating a hedge position for both parties against potential fluctuations in currency exchange rates.
The foex swap is also commonly known as rollover fees.
What is Swap in Forex Trading? - The Simplified Description:
Now I’m going to simplify the term for you. And also describe how the forex swap works.
Swap in forex trading is simply the interest rate that is either paid or charged to you at the end of each trading day. When you trade on margin (using leverage) and hold a position overnight, you receive interest on your positions that involves buying currencies of a country that has a higher interest rate, and contrary to that, you pay interest on positions selling such currencies.
[See Also: What is Leverage and Margin Trading?]
So in a single sentence, the net interest difference between the currencies you are trading (plus some other commissions), that are collected from (or given to) you by your broker depending on your open overnight positions is called as swap fees or forex swap rates.
This difference of interest rate is actually known as the "carry". A positive carry results when you receive more money as interest than what you are actually required to pay, and is added directly to your account. Contrary, in case of negative carry, the amount is subtracted from your account.
When the broker charges you the carry along with their overnight fees, it is called a swap fee.
For example, assume you are trading in EUR/AUD pair and the current bank interest rate for EURO zone is going at 2%, while the current bank interest rate for Australian (AUD) zone is 3.5%. And your broker charges 0.25% fee on top of that.
Now, If you buy EUR/AUD pair (means you buy EURO while selling AUD) and hold it for overnight, then you are buying low yield currency and selling high yield currency. Hence, this is a negative carry, and you will pay the interest difference (swap charges or negative swap) to your broker.
Alternatively, if you sell EUR/AUD (means you are selling EURO while buying AUD) and hold it for overnight, that means you are selling low yield currency and buying high yield currency. Hence, this is a positive carry, and your broker will pay you the interest difference (positive swap or swap surplus) in your account.
This swap fee only applies to positions that are held for overnight and for those who are using a margin account. This is why it is also called as rollover fee. [See Also: What is a Margin Call in Forex Trading]
If you open and close a trade on the same day or use a cash-only account then there will be no swap charges for your trades.
How the Forex Swap Rates Calculated?
By going through the above article you already know that when you hold a position open after the end of a trading day, you will either be charged or get paid interest on that position, depending on the underlying interest rates of the currency pairs you exchanged.
In the below example, we'll show you how you can calculate the swap fees that will be charged or credited to your account.
In order to simplify the example we will only consider the interest rates and the broker's commission for calculation, but in reality, the forex swap rates may depend on a variety of factors. Some of those factors are:
- The current interest rates in the two countries
- The price movement of the currency pair
- The behavior of the forward market
- The dealer's expectations
- The swap points of the broker's counterparty
Now the Forex swap example:
Let's assume that the interest rate at EURO zone is 2.0% and the interest rate at Australia is 2.75% (a difference of 0.75%) and you broker charges 0.25% on the overnight swap.
Let's say, you have opened a short position (Sell) on EUR/AUD for 1 lot. i.e. - you are actually selling 100,000 EUR, borrowing at a rate of 2.0% and buying AUD which earn interest at a rate of 2.75%.
As we know, if the interest rate of the country whose currency you are buying is more than the interest rate of the country whose currency you are selling ( as in our case 2.75 > 2.0), you will be paid the balance interest (minus broker fee) in your trading account (i.e: 0.75% - 0.25%=0.50%).
In the same example, if you had opened a long position off EUR/AUD, the bank interest rate is higher in the country (AUD) whose currency you are selling; hence, the balance interest will be deducted from your account. In that case, the total deducted fee would be 0.75%+0.25%=1.00%.
Forex Swap Fee - Example 1:
Calculating the forex swap rates on a short position of EUR/AUD:
Here we are buying AUD and selling EUR. Since the interest rate of the currency we are selling (EUR: 2.0%) is lower than that of the currency we are buying (AUD: 2.75%), This is a positive carry, and we will now put the information in the formula:
SWAP Charges = (Contract × (InterestRateDifference - Commission) / 100) × Рrice / DaysPerYear Contract: 100,000 EUR (1 lot) Рrice: EUR/AUD - 1.1200 InterestRateDifference: 0.75% (i.e.: 2.75%-2.0%=0.75%) Broker's commission: 0.25% DaysPerYear: 365 (number of days in a year) Calculation: SWAP = (100,000 × (0.75 - 0.25) / 100) × 1.1200 / 365 = 1.53 USD
So, when your short position on EUR/AUD is rolled over to the next day, $1.53 will be added to your trading account.
Forex Swap Rates - Example 2:
Calculating the swap on a long position of EUR/AUD:
When we buy EUR/AUD, we are buying EUR and selling AUD. Since the interest rate of the currency we are buying (EUR: 2.0%) is lower than that of the currency we are selling (AUD: 2.75%), this will be a negative carry. Hence the swap fee amount will be subtracted from your account.
Now, let's put the information into the formula:
SWAP = (Contract × (InterestRateDifference + Commission) / 100) × Рrice / DaysPerYear SWAP = (100,000 × (0.75 + 0.25) / 100) × 1.1200 / 365 = 3.07 USD
When your long position on EUR/AUD is rolled over to the next day, $3.07 will be debited from your trading account.
We hope that you have enjoyed the above article explaining the swap in forex trading. Be with us to explore forex trading, stocks trading, and other money-making opportunities.
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