What is SWAP in Forex Trading?
Sometimes when you close a trade, you may notice that you’re either charged or paid a certain amount of swap fees. At that moment, you must be thinking to yourself, what is swap in forex trading? And this isn’t your fault at all. In all fairness, swap is one of the most misunderstood or unknown terms in the forex industry. Many traders have not even heard about it and those that have, they’ve almost never understood it. However, this is a very important term and can seriously impact your trading if you don’t use it wisely.
Swap refers to the interest that you’re either charged or paid for a position that you hold overnight. It is also commonly referred to as a rollover rate since it rolls over a trade from one day to the next. Swap fees differ with each currency pair and broker, as well as a few other factors we’ll talk about in a bit. Since you’re already getting charged with spreads and commissions, you must be very confused about how swap came into the mix as well.
You see, if you’re getting charged a swap fee overnight, it is because you’re using leverage on your trading account. Leverage is money borrowed from a broker. In other words, it is a loan. And just like any loan, you get charged interest for every day you use that loan. Swap is therefore the interest charged for borrowing money from a broker. It is important to note that in certain circumstances, you may be paid a swap fee instead of being charged for it. We’ll get into more detail on that later. Let’s know about the types of swaps first.
Types of SWAPS in Forex
Swaps can be found in a couple of different scenarios which each represent it in a different light. Here are the four types of swaps you may encounter:
What is POSITIVE SWAP in Forex?
A positive swap refers to the scenario in which you get paid the swap fee in your trading account. This happens when the interest calculated comes back as positive. This only happens in certain rare cases where the currency being bought has a higher interest yield than the currency being sold. Currency pairs including the Japanese Yen JPY are known to have positive swap charges.
NEGATIVE SWAP in Forex
A negative swap refers to the scenario in which you are charged a swap fee in your trading account. This happens when the interest calculated comes back as negative. This is what usually occurs and is because you would’ve bought a currency that has a lower interest yield than the currency you would’ve sold.
SWAP LONG in Forex
Going long refers to buying a position in the forex industry. Therefore, swap long refers to the swap fees being charged on a long trade or in other words, a buy trade.
What is SWAP SHORT in Forex?
Going short refers to selling a position in the forex industry. Therefore, swap short refers to the swap fees being charged on a short trade or in other words, a sell trade.
How to Calculate SWAP?
The value of a swap differs due to a number of factors including broker and currency pair. It also differs by the day of the week as on certain days, you may be charged triple the usual amount due to swap charges for the weekend. Lucky for you, most brokers have a trading calculator on their website that calculates swap for you. However, if you still want to know how to manually calculate swap, we’re going to show you through an example. The formula for swap is:
Swap = (Contract x Interest rate difference +/- Markup / 100) x Price/ Days per year
In a scenario, let’s consider buying one lot of the EURUSD currency pair. Let’s assume the price is currency 1.3500 and that EUR has an interest of 4.25% while USD has an interest of 3.5%. This would make their interest rate difference 0.75%. Markup is the commission charged by the broker. Let’s assume that it is 0.25%. Since the currency we are buying has a higher interest than the currency we are selling, we will subtract the markup instead of adding it. Therefore, the swap for this scenario can be calculated as:
Swap = [100,000 x (0.75% – 0.25%) / 100] x 1.3500/365
Swap = $1.85
Therefore, you will be charged a swap of $1.85 on this trade.
SWAP FREE Situations
There are a few situations in which a swap is not charged when a trade is rolled over to the next day. They are as follows:
An Islamic trading account is just like any other account except it doesn’t charge swap fees. This is because a swap is an interest charged on borrowed money. It is forbidden for Muslims to perform any activities that involve interest. Therefore, to accommodate their faith, several brokers offer Islamic trading accounts. However, they will need to verify that you are actually a Muslim before allowing you to operate this account. It is also important to note that since a broker can’t charge a swap fee on this account, they make up for it by charging higher spreads than other accounts.
Trading in the futures market brings in another unique situation where you aren’t charged with any swap fees. Therefore, if you trade futures for certain indices such as the S&P 500 or AUS200, you don’t have to worry about getting charged a swap fee at the end of the day.
This one is pretty obvious but in the rare instance where you’re forex trading without using any leverage, you won’t be charged with a swap fee. This is because, at the end of the day, swap is interest being charged for borrowing money in the form of leverage. Therefore, if you don’t use leverage, you won’t be charged with a swap fee.
HOW TO BENEFIT FROM SWAPS
You can benefit from swaps in the rare instances where the currency we are selling has a higher interest yield than the currency we are buying. This is because this scenario results in a positive swap. This entire scenario is referred to as carrying trading. Carry trade is where you borrow a low-interest-rate currency in order to invest in a higher-interest-rate currency. This allows you to lock in a higher rate of return on your investment. The currency that is exchanged in the transaction is known as the funded currency.
FREQUENTLY ASKED QUESTIONS (FAQS)
WHAT IS THE PURPOSE OF SWAP CHARGES?
Swap is the interest being charged as a result of the money you borrowed in the form of leverage.
WHEN ARE FOREX SWAPS CHARGED?
Each broker has its own timing for charging swap but it is often charged close to midnight.
HOW CAN I AVOID SWAP CHARGES?
You can avoid swap charges by either not leaving a trade open overnight or by not using leverage.
DO SWAP CHARGES REMAIN THE SAME?
Swap charges vary depending on the broker, currency pair, day of the week, and other factors.
CAN I BENEFIT FROM A SWAP?
You can benefit from a swap in the case of a carry trade where the swap will come back as positive and be added to your account.
At the end of the day, since you made the decision to use leverage on your trading account, it is your duty to pay the interest as a result of that leverage. Therefore, we have no hard feelings for swap charges. Besides, the charges are usually very minimal and you will hardly even notice it’s there. Some traders even take advantage of the carry trading ability of certain currency pairs in order to earn from these swap charges instead of losing from them.
Now you know what is swap in forex trading. But do you know what high frequency forex trading is? Let’s know about high frequency forex trading in detail.