How Do Swap Rates Impact Traders In The Forex Market?
The forex space has many elements that distinguish the currency market from other popular financial markets – from the most liquid trading instruments to the fast-paced price fluctuations and the 24/5 operation with 4 major trading sessions. These characteristics are relevant to traders as they make the forex market unique in every sense. Another aspect exclusive to forex trading is the application of swap rates. But many traders miss out on this aspect, yet it greatly impacts your trades when you hold onto a position for more than a day.
Hence, this article is written to help you understand the impact of swap rates in forex trading and how it is applicable to you as a trader.
Decoding Forex Swap
To learn about the impact of swap rates in forex trading, you need to start by understanding the concept of forex swap. The concept of swap is directly linked to the interest rate differences of economies. The trading instruments in the forex market are international currencies that are largely influenced by the Central bank decisions and interest rates. Different currencies from different economies have different interest rates attached to them, and when they are formed into a currency pair for trading, the trader and broker will have to deal with the interest rate differences every time there is an overnight trade position.
The concept of forex swap is only applied to overnight trades, and thus, trades that get opened and closed within the same day do not fall into the scope of interest charges or swap in forex. Also, the swap becomes irrelevant for traders trading in an Islamic account because, as per Islamic principles, charging or paying interest in any form is not permitted; hence, swap charges won’t be levied on traders of the Islamic faith.
When you go long on a currency pair, you get to earn the base currency’s interest rate after deducting the quoted currency’s interest rate, which you are supposed to pay. Suppose you open a trade position to buy the USD/JPY pair; here, you will receive the interest on USD, but you owe the interest on JPY.
The story will be reversed when you are shorting the same pair, as there, you will be earning the interest on JPY while paying the interest on USD. Also, the interest rates that are taken into account for calculating the swap or rollover fee are not the actual interest rate set by Central banks but only an implied rate that applies in the market as the next rate or tomorrow’s rate. So, whether you earn or pay after applying swap rates depends on the currency pair and the type of position opened.
How Do Swap Charges Work?
The swap charges are calculated and applied by your broker every night, and the time may vary depending on the system followed by the broker. But the majority of brokers follow the New York time zone and apply the swap rates at 5 PM which can be 11 PM to 12 PM in server time. Hence, you need to check the swap timing set by your chosen broker. Also, most brokers will update their swap fees once or twice a week. Brokers also charge a weekend swap fee for trades kept open for weeks instead of days. The weekend swap might be charged on Friday or Wednesday, depending on the broker’s preference.
Traders who engage in scalping or day trading don’t have to worry about swap rates as they are not applied to positions that are closed on the same day. So, only swing and positional traders need to consider swap rates in trade-related calculations. There is also a popular forex strategy named ‘carry trading’, where traders depend on swap rates to earn profits by simply entering a trade for an extended period of time. They just open trade positions that result in swap credit (earning) due to the interest rate difference and carry forward their trades for a prolonged period.
They simply accumulate the swap credits, and this accumulated swap will be their profits from carry trading. Carry trading can be a solid strategy to gain from the positive swap by choosing a pair with a high-interest rate base currency and a low-interest rate quoted currency. USD/JPY can be a perfect pair for carry trading, but the AUD/EUR pair is apparently the most popular choice for this strategy. In addition to these pairs, USD/CHF, CAD/CHF and NZD/CHF are good options for earning profits with carry trading.
Steps to Calculate Swap Rates
There are 2 ways to calculate the swap charges for your trade position. The first one is the manual calculation, where you have to use specific formulas based on the type of position opened. Another thing to note here is that the formula will change based on whether the interest rate of the base currency is higher than the interest rate of the quoted currency or vice versa. The brokers will also add a markup to the interest rate differential, another metric to consider for swap calculation.
If the interest rate differential is equal to or smaller than the broker’s markup, you will have to pay the same for the long position. The manual calculation can be confusing and time-consuming for a trader. You also need to know about the broker’s markup on swap rates. In short, the manual calculation process is quite complex, and the chances of errors are always there.
Hence, most traders use the automated method, which involves online forex calculators which use an algorithm to carry out various trade-related calculations and give accurate results within seconds. Regarding swap calculations, you can rely on an automated forex swap calculator, a simple tool offered by forex brokers. Most brokers offer useful tools to calculate different values related to the trade, allowing traders to easily get relevant information without spending much time and effort on the tedious calculation process.
A typical Forex calculator will ask you to enter key details like currency pairs being traded, number of days for which the trade would be running, trade size in lots and account base currency. Then, it will give you results for both long and short swaps. If you are going long on the pair, the long swap will apply, and the short swap will apply in the case of shorting. If you get the result with a negative symbol, that swap will be deducted from your trading account as swap charges or rollover fees. When the result is shown without any symbols, it is actually swap credit (positive), which will be added to your account for the overnight position.
How to See a Broker’s Swap Rates in MT4 and MT5?
When you are trading on the MetaTrader platforms, be it MT4 or MT5, you can follow some simple steps to view the swap rates of your chosen broker. For this, firstly, you have to choose your currency pair from the Market Watch window by right-clicking, and then you will see the drop-down menu from which you have to choose ‘specification’, and after that, a new window displaying all the long and short swap rates for the pair will be opened. The terminal window of the MT4/MT5 platforms can also be used for seeing swap rates.
How Does Swap Apply in Short-term and Long-term Strategies?
As I said earlier, swap rates are not a matter of concern for short-term strategies like scalping or day trading. The same applies to traders who close their positions within a week or so, as the swap will not impact the profits/losses of the trade. However, swing traders and position traders should take some time to calculate swap rates in advance as the longer trade duration also increases swap charges.
What is a Swap-free Trading Account?
The swap-free trading accounts are specially designed for Muslim traders to trade without paying or receiving swaps, as it goes against the principles of Islamic finance. A swap is a form of interest; any dealing involving interest is considered a sin and thus prohibited in Islam. Hence, the swap free trading accounts are an excellent option for all Muslim traders to engage in halal trading. You must find a broker offering Shariah-compliant accounts and start swap-free trading. But the Islamic broker will also be charging a fixed admin fee to compensate for the loss of swap charges.
Bottom Line
With that, you have learned all the key aspects of forex swap and its calculation. A forex swap calculator is a simple yet essential tool for all traders holding overnight trade positions. The impact of a swap can be smaller or bigger depending on the duration of your trades. Swap rates are not something to be overlooked or ignored, as they hold the power to decide the profitability of your trades.
