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A swap is a fee that is debited or credited from/to an investor’s trading account for holding a Forex position open overnight. Most brokers consider the Forex market to open and close at 5 pm EST, marking the end of one business day and the start of another. Any position closed after 5 pm is subject to a swap fee as it has been held overnight.
This swap fee results from the interest rate difference between currencies, with the size of the swap influenced by the volume of currency traded. Forex trades, particularly in retail Forex, are commonly traded on margin. Retail traders can utilise various leverage levels, enabling a greater position size beyond the amount available in their accounts. When the trade rolls over to the next business day—rollover—even a low-interest rate difference can have a significant effect depending on the volume of currency held through leverage. The higher volume of currency held through a rollover, the more significant the swap fee becomes. The swap is deposited or withdrawn from the trading account following a rollover to another business day.
It is important to acknowledge that both high broker commissions and movement in the exchange rate can erase positive swap credits. Investors must be aware of this as they considerably affect the swap. Another intricate aspect of swaps in the Forex industry is the Wednesday three-day rollover. The investor's swap charge triples when holding a position overnight on a Wednesday. Holding a position overnight on a Wednesday incurs debits/credits 3 x the normal amount: triple swap. This accounts for the settlement of trades over the weekend.
Positive swaps are generated by buying a currency (the base currency) with a higher interest rate against a currency with a lower rate (the quote currency). In this instance, the investor generates a profit for holding a position overnight. Consequently, a negative swap comes from buying a currency with a lower interest rate against a higher rate, which causes a debit for holding an active position overnight.
A positive FX swap can lead to incremental gains through holding positions overnight (holding medium to long term). Investors can obtain positive swaps by buying (going long) and selling (going short) different currency pairs with favourable interest rates. The purchased currency in a long trade must have a higher interest rate than its counterpart. Similarly, the currency sold in a short trade has to have a higher interest rate than its counterpart to achieve a positive swap. The swap volume will become more significant with a higher trade amount. More units invested into a specific Forex trade will result in a more considerable swap return through rollover across multiple business days.
Traders look for currencies with the most significant difference in interest rates and look to hold favourable positions for as long as possible, making incremental gains.
An example of a positive long swap would be to buy Canadian dollars against the Japanese Yen. Currently, the interest rate for the Japanese yen sits at -0.10%, while the Canadian dollar has a 4.50% interest rate. This example would be a long CAD/JPY trade, resulting in a credit for the trader long this currency pair at the business day rollover. With a considerable lot size obtained through leverage, an investor can make steady returns through a rollover of multiple business days. Importantly, though, interest rates may not exactly reflect the rates that brokers have, as brokers may use their own values based on what is provided to them by the counterparties.
The final swap amount of each rollover depends on the brokerage fees and the investment size.
Forex swap trading is usually undertaken when the market is optimistic, and leading stock indices are advancing: a risk-on scenario. When the economy suffers a downturn, currency interest rates tend to decrease, providing fewer opportunities for this form of trading to be successful, which is sometimes referred to as Carry Trading.
Swap traders look for currencies with high-interest rates, usually from developing countries. These are the ones that suffer the most during times of economic instability, while stable currencies such as the USD tend to remain a safe haven for investments. Developing currencies tend to drop considerably during global economic turmoil, meaning the losses endured are too significant to be compensated by positive swaps. Swap traders, therefore, look for stable trading currencies with substantial differences in interest rates. Economic crises such as the 2008 market crash and the 2020 opening wave of coronavirus disturbed the stability of trading, which is required for swap trading to be successful.
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