We previously looked at what Forex swap is, it is now time for us to get into the details of it and see how one can gain from these swaps. Let’s us first refresh our mind and take a small recap about Forex Swap.
What is Forex Swap?
Forex Swap is an interest fee that is either paid or charged to you at the end of each trading day for holding an overnight position with your broker. It can either be negative or positive depending on what you’re selling or buying. When negative, you will lose some money for holding overnight positions. When positive, your broker will add some money to your account.
How does Forex Swap work?
In Forex, when you keep a position open through the end of the trading day, you will either be paid or charged interest on that position. And this depends on the underlying interest rates of the two Currencies in the pair.
If you hold a short position overnight on a currency with higher interest rate against a low-interest currency, you pay some fee. But if you have a long position on a currency with higher interest rate against a low-interest currency, then you receive some fee for each day that you hold that trade.
Some brokers may not charge swaps on overnight positions. This is common especially on currency pairs whose interest rate differentials is equivalent to zero or when very low.
However, sometimes, you will realise that the swap charged on your trade is larger than usual. This happens especially when you open a trade position on Wednesdays and hold it over the weekend. In such a scenario, swap charges are tripled.
Why Positive Swap?
To hold a position overnight, you pay interest on that currency sold and receive interest for the currency bought.
If the interest received from the currency bought is greater than the interest paid for the sold currency, you receive a positive swap for holding a position overnight. Your trading account gains.
For example, if you sell EUR/USD, then you are selling Euros and buying Dollars. By maintaining the position overnight, you will pay interest for selling Euros, and receive interest for buying Dollars. The fact that the U.S. dollar has a higher interest than the Euro, you stand a chance to have a positive swap.
Note:The longer the winning position is held, the greater the possible interest income accrued to your account.
Why Negative Swap?
If the interest received from the currency bought is less than the interest paid for the sold currency, you receive a negative swap for holding a position overnight. Your trading account is debited with a swap fee.
For example, if you buy EUR/USD, then you are buying Euros, and selling Dollars. By maintaining the position overnight, you will receive interest for buying Euros, and pay interest for selling Dollars.
The U.S. dollar has a higher interest than the Euro. The difference between the rates is a negative swap. This will be deducted from your account when you close out the trade. In case your trade goes against your predicted direction, you will see a bigger loss than expected when you close out the trade. This is due to a negative swap accruing on your trade.
How do I avoid Negative Swap?
You earn a negative Swap when you hold a short position for currencies with higher interest rate compared to the bought currencies. How to avoid negative swap is very simple, mind the currency pair positions you hold overnight.
We said that, sold position currencies with higher interest rates than bought positions lead to negative swap on trades held overnight. To avoid this fee, you can choose to close these positions before the end of the trading day. That is 5pm EST, (9pm GMT) as simple as that.
Can I make money from Swap in Forex Trading?
The answer is yes. You can make money from Swap fees on trades but only if you do it the wright way. How? By carry trading.
Carry trading in Forex is a type of strategy where traders sell currencies of countries with relatively low-interest rates and use the proceeds to buy currencies of countries with higher interest rates. Here, the Forex trader borrows money in one country with a lower interest rate, and invests it in another country with a higher interest rate with an aim to benefit/profit from interest differences.
In order to successfully benefit from carry trading, the first step is to find a Forex currency pair with high interest differential.
Some examples of low yielding rates are the Japanese Yen (JPY), the Swiss Franc (CHF) and the Euro (EUR). The most popular high yielding currencies to look at are, the U.S. dollar (USD), the Australian Dollar (AUD) and New Zealand Dollar (NZD).
For instance, if we consider the U.S. dollar and Japanese Yen (USD/JPY) as the yielding pair. Current rates for the dollar is 2% and the Yen rate is -0.1. Holding a buy position overnight on USD/JPY, you earn a positive carry/swap.
However, this is more meaningful when a trade is moving to your predicted direction. There is no point earning a pip a day in swap if the pair is moving against you 100 pips a week.
- Find a pair with the highest interest rate differential.
- The pair should be stable or in favour of an uptrend for the currency with a high interest rate.
- Identity your risk before entering a trade. Study the current economic conditions in the countries involved and relate to fundamental and technical analysis.
Finally let’s conclude by showing how swap is added or deducted from your trading account.
How swap is added or deducted from your trading account?
Forex Swap is calculated automatically at the end of every trading day. For Wednesday to Thursday rollover, swap is deducted/added in a triple size.
In the Forex market, when you hold a position open overnight from Wednesday to Thursday, swap is tripled. This is because the value date is moved forward 3 days, to Monday (skipping over the weekend). The banks are closed on weekends. Swap is tripled because you are paid or charged interest for 3 days instead of just one.
You can see the size of the swaps in the trading terminal on the MT4/5 platform in regard to the position you are holding. Swap is deducted from/added to our account automatically when you close your position.
If you see a swap fee on your position in the trading terminal on the platform, try to compare the value at which you closed your trade and the real profit/loss earned after closing out the trade.