There are various costs and mechanisms in forex trading, one of which is called the swap. In forex, a swap refers to an interest fee that is either paid or earned by trades holding positions overnight. The interest fee is because of the difference between interest rates in currency pairs.
Since swap is a critical concept in forex trading, it’s important for traders to learn about how it works, how they can use it to their advantage, or how they can seek ways to avoid swap altogether.
Understanding Swap in Forex Trading
In forex trading, a swap is when interest is paid or received after a trader keeps a position open overnight. The interest comes from the fact that currency pairs have different interest rates. Since every position involves buying one currency and selling another simultaneously, and different countries have varying interest rates, there will always be a difference in interest rates. This difference is what determines whether the trader is paid a swap fee or has to pay a swap fee.
If the trader buys a currency with a higher interest rate and sells a currency with a lower interest rate, then the difference is called a positive swap. However, if the trader buys a lower-interest currency and sells a higher-interest currency, it becomes a negative swap. The interest rates depend on many global economic factors as well a central bank policies.
Let’s use a concrete example. Let’s say that a trader buys AUD/USD, meaning they are buying the Australian Dollar while selling the US dollar. If Australia’s interest rate is higher than that of the US, it’s a positive swap. If the US’s interest rate is higher than Australia’s, it’s a negative swap. In the first case, the trader earns a swap fee, whereas in the latter case, they have to pay a swap fee since they are holding the lower-interest currency overnight.
How to Calculate Swap in Forex?
There is a standard formula that traders can use to calculate swap which takes the lot size being traded alongside the interest rate differential and the currency pair into consideration.
Swap = (Pip value x Swap rate x Number of Nights)/10
Let’s say that a trader holds a 1 standard lot long position in EUR/USD. The following are the interest rates of each currency:
- EUR interest rate: 2.5%
- USD interest rate: 1.5%
- Swap rate provided by the broker: +0.8 pips per lot
In these example conditions, if the trader holds their position overnight, they will earn 0.8 pips. However, if the swap interest rate was negative, the trader would pay this fee instead of earning it. Overall, the final value will depend on the trader’s position size and their broker’s rollover policy.
Swap fees are automatically added or deducted from or to the trader’s account at the daily rollover time. Every trader should check out the swap rates on their broker’s platform or use swap calculators to avoid any unexpected costs while trading.
How to Avoid Swap Fees in Forex?
Traders usually want to find ways to avoid swap fees if they can. This is especially true when a trader wants to hold a position for an extended period. One of the best ways to do so is to use a swap-free account. These accounts are primarily used by Islamic traders who are prohibited by Shariah law to pay or earn interest.
Another strategy that can help traders avoid swap fees to the best of their ability is to trade currency pairs with minimal interest rate differentials. In these cases, the swap fees will be negligible since the interest rates are so similar. To better implement this strategy, traders should both check forex economic calendars and central bank announcements to monitor interest rate changes and adjust positions accordingly.
Traders can also close their positions before the daily rollover time of their broker to avoid overnight charges. This method is usually used by day traders to prevent swap fees from accumulating, but it also requires precise and active monitoring of the market alongside disciplined trade execution.
What is Swap-Free in Forex?
Though swap-free accounts in forex trading are particularly popular among Islamic traders since they don’t charge overnight fees, they are also used by some non-islamic traders in order to not pay interest. They are particularly preferred by Islamic traders since they want to avoid paying or earning interest (Riba) and are worried about whether forex trading is Halal or not.
Since the accounts are swap-free, usually brokers add other conditions to these accounts. For example, brokers might put restrictions on the currency pairs that can be traded or have slightly wider spreads.
For non-Islamic traders, swap-free accounts can be tempting, especially if they plan to hold a position for an extended period. However, before opening such accounts, it’s important to go over the terms and conditions the broker has for their swap-free accounts since they may impose alternative charges to compensate for the absence of swaps. After calculating the total cost of trading, including spreads and commissions, and alternative fees, the trader can deem it to be a good decision, business-wise, to open a swap-free account.
Swap Insights: The Key to Smarter Forex Trading
Swap fees play an important role in forex trading and every trader should be familiar with the concept. Traders should understand how to calculate swap fees, check out economic calendars, and implement strategies to pay the least amount for a swap fee possible. Though minimizing swap fees a trader has to pay is always a priority, sometimes it’s inevitable.
For those looking to bypass swap fees altogether, using a swap-free account, pursuing day trading strategies, trading currency pairs with similar interest rates, and calculating swaps using swap calculators are all good strategies to pursue. For Islamic traders, swap-free accounts are the best option to engage in forex trading while remaining respectful to their beliefs and Shariah law.
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