What is Swap in Forex Trading?
- The Simplified Description:
Now I’m going to simplify the term for you. And also describe how the forex swap works.
Swap in forex trading is simply the interest rate that is either paid or charged to you at the end of each trading day.
When you trade on margin (using leverage) and hold a position overnight, you receive interest on your positions that involves buying currencies of a country that has a higher interest rate, and contrary to that, you pay interest on positions selling such currencies.
[See Also:What is Leverage and Margin Trading?]
So in a single sentence, the net interest difference between the currencies you are trading (plus some other commissions), that are collected from (or given to) you by your broker depending on your open overnight positions is called as swap fees or forex swap rates.
This difference of interest rate is actually known as the "carry".
A positive carry results when you receive more money as interest than what you are actually required to pay, and is added directly to your account.
Contrary, in case of negative carry, the amount is subtracted from your account.
When the broker charges you the carry along with their overnight fees, it is called a swap fee.
For example, assume you are trading in EUR/AUD pair and the current bank interest rate for EURO zone is going at 2%, while the current bank interest rate for Australian (AUD) zone is 3.5%.
And your broker charges 0.25% fee on top of that.
Now, If you buy EUR/AUD pair (means you buy EURO while selling AUD) and hold it for overnight, then you are buying low yield currency and selling high yield currency.
Hence, this is a negative carry, and you will pay the interest difference (swap charges or negative swap) to your broker.
Alternatively, if you sell EUR/AUD (means you are selling EURO while buying AUD) and hold it for overnight, that means you are selling low yield currency and buying high yield currency.
Hence, this is a positive carry, and your broker will pay you the interest difference (positive swap or swap surplus) in your account.
This swap fee only applies to positions that are held for overnight and for those who are using a margin account.
This is why it is also called as rollover fee. [See Also:What is a Margin Call in Forex Trading]
If you open and close a trade on the same day or use a cash-only account then there will be no swap charges for your trades.