Transactions made with a broker/dealer in the Forex trading are subject to receive or pay interest if the positions are kept open until the next settlement day.
This is what is known as the overnight position (the operation is kept open overnight). Interest charged or received in this transaction is called rollover interest, rollover rate, or only rollover. It is also very common to find it as a swap because it implies an interest rate swap.
In this article, we will see why the rollover exists and how Forex traders can benefit (or not) from this interest.
What is Rollover?
In Forex, all positions have a maximum settlement date of 2 days. This settlement date can be extended by dragging the position. This drag, or rollover, can be understood as a renewal of the position.
Usually, the rollover is performed automatically on all brokers. This renewal of the position is accompanied by the liquidation of interest generated by each of the currencies that is part of the pair in which the operation is open. That is where an interest rate swap takes place.
The rollover occurs in all positions that remain open at UTC (5:00 p.m. EST) 10:00 p.m. during all the days. These positions are known as overnight positions for staying open at night 17:00 EST (New York time). An operation open at 16:59 EST and closed at 17:01 EST is considered an overnight operation and will be subject to rollover.
The rollover rate applicable on trader is calculated by the difference between the interest rate of the currency you buy and the interest rate of the currency you sell.
Remember that in Forex, all operations are carried out in currency pairs and involves the purchase of one currency and the sale of another since the exchange rate is the relative value of one currency with respect to another. e.g., if a trader purchase EUR / USD, he will receive or pay the rollover interest obtained from the variation in the European Central Bank interest rate and the Federal Reserve interest rate.
In the majority cases, the broker / dealer apply the rollover automatically. Retail brokers apply the rollover to prevent the vast majority of speculators from having to deliver the current value of the exchange to the counterpart of the operation.
The settlement date, which is the day on which the broker would have to deliver the real currency to the counterpart of its operation, is two business days after the day on which the operation was carried out.
If the rollover does not apply, the broker would have to deliver the nominal rate of the currency to the counterparty.
This is due to the fact that in the currency market, it is traded with contracts to exchange one currency for another that must be delivered in 2 business days.
It is vital to note that the rollover is the interest paid or received by the trader is based on the sum value of its operation and not the margin used. e.g., if an operator executes an operation of a lot in EUR / USD, the rollover will be calculated for $ 100,000 (total value of a lot).
It is also essential to consider that the rollover is not a charge for the use of leverage. People believe that the charge of the rollover represents “the cost of the trader,” which is totally wrong.
The rollover is based on the variation between the interest rates of the countries involved in the currency pair in which the trader has an open commercial operation, nothing more.
In order to calculate rollover interest, we need the short-term interest rates of both currencies, the current exchange rate of the currency pair and the amount involved in the operation. e.g., suppose a trader performs a purchase transaction of 10,000 EUR / USD. The current exchange rate is 0.9155, the short-term interest rate on the euro (base currency) is 4.25%, and the short-term interest rate in the US dollar (quoted currency) is 3.5%. In this case, interest in rollover is $ 22.75, ((4.25% – 3.5%) / 360) x (10,000 / 0.9155).
The calculation of the rollover can be expressed using the following formula:
Rollover = ((Ic – Iv) / 360) x V
- It is the interest rate associated with the currency purchased
- It is the interest rate associated with the currency sold
- V is the total volume of the transaction expressed in USD (or in the denomination currency of the trading account)
- 360 is entered to perform the calculation on a daily basis since the rollover interest is annual (365 if the ATC / 360
- Ic banking standard is not applied – Iv is the rollover interest or rollover rate
The number of currency units purchased is used because it is the number of units owned by the trader. Short-term interest rates are used because these are the interest rates of the currencies involved in the currency pair of the operation.
In our example, the trader owns Euros, for which he or she earns 4.25%, but must pay the loan rate in US dollars, 3.5%. The difference between the two is positive, and the rollover will be added to the trader’s account.
If we put the same example, but with sales instead of purchase, the difference between both interest rates would be negative (interest on the currency purchased would be 3.5%, and the currency sold 4.25%). The trader will have to pay the rollover amount that will be subtracted from your account balance.
Credits and debits in the business account
If the rollover will result in credit or debit for the trader, it is determined by the currency that the trader has purchased.
If the interest rate in the country of the currency you have purchased is higher than the interest rate of the other currency of the pair (the one that the trader sells), the trader will receive a positive rollover that will be credited to your account. e.g., if an operator buys in USD / JPY, that is, he buys US dollars and sells Japanese yen if the US. It has an interest rate of 2% and Japan of 0.5% so that the trader will receive a 1.5% annual interest of the value of his position.
If the merchant sells USD / JPY, which means that he sells USD and buys JPY, then the differential rate between the two countries would be charged.
A broker will be paid interest every day that he has an overnight position in which the interest rate differential is positive, or interest will be charged to his account every day that he maintains an overnight position in which the differential of interest rates is negative.
Normally, the rollover is added or subtracted from the account balance of the trader automatically at 17:00 EST. Although very rare, the rollover can also be applied by adjusting the entry price of the operation.
Get benefit from Rollover
As seen, the rollover can result in a sum of capital in the trader account. That is why; operations in Forex can be carried out, taking into account interest gains in addition to the benefit of fluctuations in the exchange rate.
In this sense, in the face of a position that accrues a positive rollover for the trader, the trader can decide whether to maintain a slightly more position to obtain this benefit or maintain long-term positions in a currency pair in the direction in which Rollover interest is positive.
The rollover is the basis of the carry trade, a strategy that seeks to maintain long-standing positions in currency pairs with a high difference in interest rates, buying the currency with higher interest rates and selling the other.
It should be noted here that interest rates are not fixed and may change over time according to the decisions taken by the respective Central Banks.
e.g., if a broker estimates that the exchange rate of a currency pair will remain comparatively stable during the year or so, then the trader can take advantage of the difference between interest rates and obtain a good profit.
The interest in a rollover is very similar to the interest payable in the balance of a bank account. Therefore, the rollover is taxed as interest income, and a separate accounting of capital gains must be maintained for tax reasons.
The activity reports of the traders’ accounts issued by the brokers must show the interest paid/collected.