Understand Why Forex Brokers Take Swap Rates

Understand Why Forex Brokers Take Swap Rates

What happens when a forex trader leaves a position open overnight?

In the forex market, when a position is kept open overnight, a trader will either get paid or be charged interest on that position based on the underlying rates of the currencies in that pair.

Swap Rates

Therefore, it means that the forex swap can be negative or positive, and when negative, a trader loses money, but when positive, a broker adds some money to the account.

Unfortunately, the majority of traders, especially novice traders fail to recognize it as it’s minimal compared to the direct profit or losses they get when trading.

Now, it’s true then than there’s a rollover interest for positions left open overnight. But, why do forex brokers charge or pay the overnight interest? Some brokers even promote interest-free accounts; why?

Why they occur

Trading currencies means trading cash. When a trader goes long on a particular currency, it’s like holding some deposit in a bank and expecting to get an interest in the deposit. When going short, it’s like borrowing and expects interest to be paid on loan.

Because every trade currency involves borrowing a currency and buying another, the interest rollover charges are, therefore, part of forex trading.

The interest is paid on a currency borrowed, and then earned on the one bought.

Basically, the overnight interest originated from the fact that the retail forex market doesn’t involve physical delivery of currencies.

The interest rates when it comes to overnight interbank lending are set merely by the central banks.

For instance, the rate paid for borrowing dollars from a broker is entirely controlled by the FRS (Federal Reserve System) and the interest rate a broker pays for borrowing Euros is set by the European Central Bank, and the difference between them is the eventual swap rate or overnight interest.

Unfortunately, in reality, brokers don’t pay or even take exact amounts for overnight interest.

They only minimize the swap when paying it out and then maximize it when the trader pays it. Therefore, all they do is only to try and avoid risks, which isn’t very fair, right?

But why is it that some brokers claim not to take or pay overnight interest?

The main reason is typically straightforward – the interest is perceived as inappropriate by the Islamic religion.

Other brokers offer accounts that are interest-free on request and then charge some fixed commission for every trade to compensate the interest-based losses. Some others provide interest-free accounts as well as don’t charge commissions.

Is Overnight Interest Advantageous?

Swap Rates

You can use the overnight interest to your advantage if, for example, you use it for Carry trading.

For instance, if your instincts point that the currency pair having a substantial positive interest rate difference will remain stable or even move in a direction favouring you for an extended period, then you can move and use the broker’s leverage and receive high interest rate from swaps only.

Furthermore, you can take route number two and open an account with different brokers. Open one account with a broker that doesn’t offer interest policy, and the other with the normal forex broker. It, therefore, means that you’ll be able to hedge the positive interest rate difference position easily with a no-interest rate position with the other broker.

In other words, you won’t be interested in the market movement, but interestingly, you’ll be gaining advantage from positive overnight interest.

The Bottom Line

Understanding the logic behind the swap rates is an interesting one, especially for any trader seeking to hold positions overnight.

You have to thoroughly investigate what the offer is when shopping around for the brokers as well as be aware that the speed of the price movement in your favour can have a significant effect on the profitability of any momentum or trend strategies utilized.

Being credited or debited depends on whether the trader holds a short or long position and also the interest rate differential between two currency pairs being traded.

Author : Michael Fasogbon

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Michael Fasogbon is a professional Forex trader and cryptocurrency technical analyst with over five years of trading experience. Years back, he became passionate about blockchain technology and cryptocurrency through his sister and has since been following the market wave.