Forex Swap – what is it and why it is important to pay attention to it?

As a forex trader it is important to know all aspects of the business. There is a lot of theory as in any other area but to be on your best game you must be aware of it all. One of those aspects is the swap. In this article I will cover what the swap is and why is it important in our trading. Let’s start with the first subject:

What is Swap?

Definition:  A forex swap rate is defined as an overnight or rollover interest (that is earned or paid) for holding positions overnight in foreign exchange trading.

Forex is traded always in pairs (eur/usd, usd/jpy etc) and in reality you borrow one currency to buy the other. When you borrow a currency think of a loan to which you have to pay interest (just like a loan from the bank). It just that you pay the interest on daily basis. The other currency in the pair you own so you are earning from the interest. The swap is simply the difference between the interest that you are earning and the interest that you paying.

In summary:

Forex is traded in pairs. You pay interest on one of the currencies (of the pair) and you earn interest on the other one. The difference between the two interest rates is called the swap.

Most brokers use interbank overnight rates for their calculations and thus you pay the swap on daily basis. There are however brokers who try to be more competitive by offering swap-free accounts. The so called “islamic-accounts” are swap-free because of religion issues.

Swap-free or islamic account however are charged commissions. There is no free lunch. It is not that every broker is offering such type of accounts though. You have to do your home work and check which one is best if you are going for one.

How is swap calculated?

Example: Trading 1 lot of EUR/USD (short) with an account denominated in EUR.

• 1 lot = 100,000
• Pip value = $10
• Swap rate = 0.54
• Number of nights = 1
• Swap fee: (10 * 0.54 * 1) / 10 = $0.54

There are many online swap calculators where you can determine the swap that you will pay on your trade like this one: Swap Calculator.

Why is swap important?

The sad fact is that negative swap (what you have to pay to the broker) is always higher than the positive swap (what you earn from the broker).

This is why it is important to be aware of the swap charges. If you are going to hold a position for a longer period of time you will be definitely interested in what you are going to pay or earn.

If you are an intra-day trader or relative short term one, swap is not going to do much difference in the overall performance and results.

Carry Trading – A Swap Strategy

There is a method of trading called Carry Trading used by large investors such banks and hedge funds. Carry trading in essence is borrowing a low interest rate currency, than converting it to a high interest rate currency and holding this positions for a period of time. Watch the video below which explains the idea of Carry Trading in details:

 

I hope this article helped you answer the main questions: what is swap, why is it important and how to calculate it? If you still have questions please feel free to comment below.

If you like this post share it!

Yours,
Vladimir

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