What is a forex swap?
What is swap on the exchange in simple language? What are the types of swap? How to calculate the size of the swap? What are accounts without swaps? How to trade with a swap long-term trader?
Good afternoon, gentlemen traders! Today we will talk about swaps in Forex trading, what it is, where they come from, why there are negative and positive swaps, what the size of the swap depends on, where to look at the table of swaps with your broker, why it’s sometimes unprofitable to keep the position open for a long time, need trading accounts without swaps and more.
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What are swaps?
A swap is essentially a type of forward contract. When the two contracting parties enter into an asset swap agreement on a specific date in the future, swap contracts are concluded. In swap contracts, one part of the contract is static and the other is dynamic, because it depends on future results. This future result can be anything that the two parties agree on before concluding a contract. The price of stocks, goods or bonds, changes in interest rates determined by the Federal Reserve, price fluctuations in foreign currency exchange rates are one of the common future results on which swaps are based. Swaps are not regulated and have a higher risk of default than any of the regulated contracts. However, swap contracts are executed by large banks and are equally credible.
There are three types of transactions in foreign exchange trading. One of them is the spot market, a place where transactions are made with the price of the currency at the time of the transaction. The second is the forward market, which is an agreement between traders for currency exchange at a price that will be agreed in the future. Swap contracts include both of these types of transactions.
A forex swap is a contract between a trader and a broker about exchanging the amount in foreign currency for an equal amount of any other foreign currency based on the exact rate at the time of the conclusion of the contract. Then the trader will be obliged to return the original amount exchanged later, at a certain forward rate. This exchange rate is fixed at the exchange rate at which the currency will be exchanged at predetermined dates. Changes in interest rates over time of the respective currencies are ignored during the exchange. Forex swaps basically act as a hedge for both parties and eliminate unexpected or unwanted fluctuations in foreign currency exchange rates.
See also which Forex brokers offer CFD trading .
How can you make a profit from swaps?
The profitability of a swap commission ultimately depends on the type of swap that any trader accepts. In interest rate swaps, you can get high profits by involving their transactions in high volume and high interest rates. These swaps should be hedged to eliminate or at least reduce risks. For example, if a trader pays a fixed rate and gets a floating rate, he will pay lower interest if the rate rises. But they will receive a higher floating rate, since reception rates are higher. These types of swaps bring more profit while reducing risk.
Similarly, in a currency swap on Forex, currencies are exchanged at the end of a contract, and interest rate coupons are paid based on the interest rate of that country. For example, you want to receive CAD in the future, exchanging for USD. If the value of the US dollar falls against CAD, you will make a profit as the CAD value increases, so you will pay less CAD for the same amount in US dollars and vice versa.
Different types of swaps and related fees
There are different types of swap fees. Some of the major swaps include interest rate swaps, where swap commissions depend on the difference between interest rate volatility. Currency swaps are those in which commissions for swaps are calculated based on the price difference between two foreign currencies and their exchange rates. Using these swaps, traders can get loans at low prices and hedge them from fluctuations in interest rates. Another type of swap is zero-coupon swaps. Companies use these swaps to hedge their loans, for which interest is paid at maturity. Banks also use zero-coupon swaps to insure their borrowed assets with interest payments at the end of their maturity. There are many other swaps, such as total profit swaps, credit default swaps and commodity swaps, which have their own advantages and fees.
How is the swap charge calculated?
As a rule, when you hold an open position after the end of the trading day, you get either paid or accrued interest. It depends on the existing interest rates of the currencies that you exchanged. Currency swap rates usually depend on various factors: price movements of currency pairs, broker commissions, interest rates both currencies, market behavior, etc. Let's consider only the interest rates of currencies and broker fees in our example for a better understanding.
Suppose you want to change 1 lot USD with CAD for a night position for sale. The interest rate in US dollars is 2.0%, and in Canadian dollars - 2.75%. Let's also consider a broker's commission of 0.25%.
The formula for calculating the fee for a swap:
[CS × (D - C) / 100] × P / 365,
where CS is the contract size;
D - the difference between the interest rates of both currencies;
C - broker commission;
P - exchange price.
Substituting the values in the formula above, we get the following:
Swap size = [100,000 × ((2.75 - 2.00) - 0.25) / 100] × 1.34 / 365 = $ 1,835.
Therefore, when your short position in USD / CAD is moved to the next day, $ 1,835 will be added to your account.
See also list of the best Forex brokers.
What is swap on a stock exchange in simple language?
Let's summarize the article and tell in simple words what a swap is for novice traders. The currency swap on Forex is the difference between the interest rates of the central banks participating in the transaction. The value of this variable, and can be both positive and negative. Swap is charged or charged for transferring an open trade to the next trading day. And in the night from Wednesday to Thursday, a triple swap is charged or charged over the weekend. Also, the broker commission is included in the swap. The size of the swap can be viewed in the swaps table at your broker (in the contract specifications). Sometimes a single currency pair can have both a negative and a positive swap. For example, when selling a currency pair, you may be credited with a positive swap, and when you buy it - a negative swap. This is especially common in exotic currency pairs. There are also swap strategies designed to earn a positive swap.
What are accounts without swaps?
There are so-called Islamic accounts without swaps - Swap-Free. They were created by brokers specifically for Muslim traders who, according to Islamic law, prohibited any form of usury, that is, making a profit without creating real wealth. Instead of a swap, only broker’s commission is present on such accounts. Not only Muslims, but also medium-and long-term traders can use accounts without swaps.
See also what are cryptocurrency brokers.
Thus, a forex swap is a fee for postponing a position to the next day, charged by a broker. Swap can be positive and negative. You can additionally make a positive swap by opening deals only for selling or buying on certain exotic currency pairs (see the swaps table at your broker). If you trade within a day, then the size of the swap doesn’t matter for you, you can ignore it, in this case accounts with a minimum spread, as you often open and close trades during the day. If you are a long-term trader, we recommend that you monitor the size of swaps or open accounts without swaps, so you reduce your costs during long-term trading from a week or more. Profitable trade to you!
See also the article “How much to start trading on Forex?”.