What is swap in forex trading

What is Swap in Forex?

Let us get you up to speed on everything there is to know about swaps in the forex market.

A forex swap is a daily interest charge that is either billed or credited to you at the start of each new trading day if you are holding positions from the day before.

Swap charges can add up over time, affecting the profitability of your positions, so it’s important you understand how they work and factor them into your decision-making when planning your attack on the market.

Forex swaps can be a little confusing to the uninitiated as the term swap is used in various fields of finance.  Other names for forex swap include rollover and carry – these are less ambiguous as they only refer to the overnight interest charges we’ll be talking about here.

The term swap comes from the fact that through buying and selling currency on margin, you are swapping one interest obligation/right for another offsetting one.  Rollover comes from the fact you are rolling your position over from one day to another, as does carry.

Every currency pair you trade will have its own interest charge or credit rate applied to long or short positions, unlike exchange rates, these rates don’t fluctuate very often in normal market conditions.

They will generally slowly move in one direction over time with changes in monetary policy.

Forex Swap Explained

Why is swap paid and levied in the forex market?

When trading in the forex market, you are always using some leverage.

You never physically change the ZAR or USD in your account for any other currency.  The currency in your account is your collateral, used to borrow and take positions in other currencies.

If you open up a short position in USDZAR, you are borrowing US Dollars and selling those dollars to buy the Rand.  If the Rand strengthens against the US Dollar and you close your position, you sell the Rand, use the proceeds to pay back the US Dollars borrowed, and keep any difference as your profit.

While you were borrowing US Dollars, you were levied interest charges on that loan, but while you were holding Rand, you were receiving interest on your holdings.  The difference between these two interest liabilities/rights is swap.

As South Africa consistently has a much higher interest rate than the US, you will likely always be paid swap on this trade and always be liable for it if you take the other side, betting against the Rand.  This is important to consider when making trading decisions based on a longer-term thesis – you may be right that the US Dollar is going to appreciate over the next 6 months, but is paying interest on a long USDZAR position for an extended period of time the best way to capitalise on your thesis?

You may want to look elsewhere in this case for a currency with interest rates closer to the US, reducing your swap liabilities whilst still betting on prolonged USD strength.

exchanging money to demonstrate what is swap in forex

Conversely, if you are seeing prolonged USD weakness over the coming months, a short USDZAR position could be the perfect play as you will profit if your thesis is correct and receive daily interest payments for the duration of your trade either way.

Who sets swap rates in the forex market?

Swap rates in the forex market are determined by your broker, based on the rates they pay and receive in the interbank market.  In turn, these rates are based on the official cash rates set by the world’s central banks.

Brokers have to charge a small markup spread to manage their own risk and generate a profit from their brokerage activities.  As such, if you are trading a currency pair where the official interest rate difference is only small, you are unlikely to be paid swap on either side of the trade, but you will only pay a tiny amount on whichever side you take too.

If you don’t want to worry about swap charges, pairs like this with small rate differentials can be a great option.

Forex swaps in practice

Forex swaps will be levied or credited to your account every day at 4:59 PM NY, the end of the trading day, regardless of what time zone you live in or how long you have had your trade open.

This means if you hold a trade past that time, you will pay or be credited a full 24 hours of interest, regardless of whether or not you held the trade for 10 minutes or 12 hours.  For short-term, highly leveraged trades, this is definitely something you want to keep in mind – note you pay/receive interest on your position size, not the balance of your account.

Another thing to consider is the 3 x swap day, this is generally Wednesdays but can vary between brokers.  At the end of every Wednesday, traders who are rolling over their positions will pay or receive a full three days of interest charges on behalf of traders who will be holding over the weekend.

The sense in this, or whether or not it is equitable, is beside the point – it’s simply something you must be aware of as a forex trader.

If you want to avoid paying 3x interest, you could close your position before Wednesday’s close and re-enter once the new day begins and spreads settle down.  On the other hand, profiting on the 3x interest may be a little harder with a short term trade due to the wide spreads at this time of day – if you are entering a position to earn swap before the day ends, you should be happy to hold the position for at least an hour, as spreads may be wider than the swap you received at the start of the trading day.

Lowest forex swap spreads in Africa

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