What is Swap in Forex?
Have you been looking at opening a trading account and found yourself puzzled trying to understand what is a Swap in Forex? A Swap in Forex is an interest payment that you either settle or collect for carrying positions overnight into the following day. Swaps in Forex play an important, yet confusing role and they affect your trading strategy, sometimes without you even noticing.
If this isn’t the first article that you’ve read about Forex Swaps, then we sympathise. Unfortunately, the phrase Swap can have a different meaning in varying contexts. Allow us to enlighten you. In this article, we will explain precisely what is a Swap in Forex from the perspective of a Forex and CFD trader.
A Swap in Forex is sometimes referred to as a Rollover, as you roll the trade over to the following day. Every currency pair will have a different Swap Rate that is applied to either Long or Short positions. Brokers often update the Swap Rates in their trading platforms to reflect the market. Unlike the Bid and Ask prices which update several times a minute, Swap Rates are updated once a day at most, but sometimes less often than that.
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Why are Swaps in Forex Applied?
When you trade Forex with an online CFD broker, you do not and will not take physical delivery of any of the currencies you are trading. All profits are settled in the same currency as your trading account is denominated in. If your trading account is set in GBP, all profits are settled in GBP. This means you are essentially borrowing any currencies you are trading.
Don’t confuse this notion of borrowing with leverage. Even if you trade without leverage, you still will pay or earn exactly the same Swaps as if you had a 1:500 leverage setting on your account.
If you are Long EUR vs USD, then you are giving Euros and borrowing US dollars. This means you are earning interest on the Euros and paying interest on the US Dollars you are temporarily borrowing.
The Swap Rate will be determined by the set interest rate differential between the two currencies, which in this example would be the interest rate for depositing Euro minus the interest rate for borrowing US Dollars.
Who Sets the Forex Swap Rates?
Central Banks set swap Rates, or at least that’s where the rates originate. As a retail Forex trader, you’re quite a few levels away from trading with the Banks.
Unfortunately, the Forex Swap rates you get from your broker are likely going to be watered down so much so that it would be unlikely that you could make a profit from positive Swap Rates.
Don’t be too disheartened by this. After all, you’re not really depositing money at a bank nor are you taking physical delivery of any currency. For an online Forex trader, the conditions are very different.
How Swaps in Forex Work?
It’s logical to think that Swaps are calculated at midnight in the timezone of wherever you live or perhaps after your position has been open for 24-hours. In fact, you could be paying Swaps for having your trade open for just ten-minutes.
Unless you have a Swap-free trading account, Swaps are charged at 4.59 pm New York time each day. The end of the New York session is the end of the trading day. Moments later, a new trading day begins as the Auckland session begins.
Here are some other crucial details about Swaps in Forex that you should be aware of;
- The Swap Rate: The Swap Rates set by your broker can change from day-to-day. They also vary between different trading pairs.
- The size of your position: The larger your position, the more you will pay or collect.
- The direction of your position: Swap rates vary depending on whether you are Long or Short.
- The day of the week: Some brokers charge triple Swaps, which means you pay or collect three times as much on a particular day of the week if you roll your position over to the next day. This event can occur on a Friday, Monday or even Wednesday.
- Your trading account currency: Swaps are deducted directly from your trading account balance as and when they are charged. If you keep a position open for two days and the Swap Rate hasn’t changed, you could pay or receive different amounts due to differences in exchange rates between your account balance currency and the quote currency.
How are Swaps Calculated?
When you hear that Swaps are related to interest rates, you might think they are expressed as percentages or easy to understand dollar amounts. In fact, retail Forex trading accounts calculate Swaps in Points. This notion is relative to the fact that Spreads, Commissions, Profits and losses all revolve around Pips and Points.
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Let’s examine how Swaps in Forex are calculated with a hypothetical situation.
The Swap Rate for Euro vs. US Dollars is -4.83 Points for Long positions and -0.81 for Short positions.
In this example, you would be paying Swap charges for both Long and Short positions. For a long position, you would pay 0.483 Pips per Lot; so what does that mean?
Let’s say you have a Long position that is 0.2 Lots in size, and your trading account balance is in Great British Pounds, and the GBP vs USD rate is 1.31.
Pip value = $10
Swap Rate in Pips = -0.483
Position Size = 0.2
($10 * -0.483 * 0.2) = -$0.966 /1.31 = 0.74 GBP
Final Thoughts on Understanding What is a Swap in Forex
New Forex traders often overlook Rollover costs when looking for a broker to trade with. Researching what is a Swap in Forex is often an afterthought for many traders. It’s usually a seemingly obscure fee deducted from their trading account balance which initiates this retrospective investigation.
Swap Rates can vary widely from one broker to another, so it’s most definitely not something to negate from your decision-making process. Always compare and evaluate Swap rates when choosing a broker as you never know when you will need to carry a trade over to the next day.
It’s also worth noting that Swaps aren’t just applied to currency pairs. You can also expect to see Swaps used for other instruments offered by many Forex brokers. For example, Gold vs. US Dollar or DAX vs Euro.
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Hein is a Forex and CFD enthusiast with a passion for writing good informative quality content. He strives to showcase the best Forex Brokers in South Africa. Join him on his Jounrney!
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