Forex Swaps – How Do Forex Swaps Work?

Forex swaps, or overnight fees, in practice are fees charged by almost all Forex and CFD brokers on all open trading positions maintained overnight, daily. They can be a substantial cost for longer-term traders. This is cost is often called a “hidden cost,” as most brokers do not publicize this fee although they tend to be relatively open about more visible trading costs such as spreads and commissions.

In this article I will explain what Forex swaps are and how they work, so if you are or plan to be a longer-term trader, you can plan accordingly and act to preserve your profitability.

What are Forex Swaps?

Traders will either pay or receive payment on Forex swaps depending upon the rate determined by their broker if they hold a position past the rollover point each trading day, usually at 17:00 EST. When trading a leveraged portfolio, traders borrow funds from the broker to open positions. Therefore, a Forex swap rate can be an interest rate on the borrowed funds.

Since 2008, due to the generally low interest rate environment in all major currencies, positive swaps – where the trader gets paid to hold a position open – have become very rare. Almost every swap on every trade since 2008 has been a fee, not a payment.

A Forex swap in theory represents the difference in interest rates between the base currency, the first currency in a quote, and the quote currency, the second one. For example, in the EUR/USD, the euro is the base currency, and the US dollar is the quote currency. If you are long of a currency with a low interest rate and short of a currency with a higher interest rate, you can expect the swap fee to be higher. If the situation is reversed, you can expect the swap fee to be lower. In rare cases, you might even get paid a little on the swap.

The key takeaway is that in practice, you will pay a small fee every day on almost every trade you have open at 5pm New York time, whether it is long or short. This is bad news for longer-term position traders, because this daily fee can build up and erode the profits available to good trend-following trading strategies.

Noteworthy:

Most Forex transactions settle with a two-business-day delay, also known as T+2. Since the Forex market remains closed on weekends, but daily swap rates are payable, each Wednesday, Forex traders pay or receive triple the Forex swap rate to account for the weekend.

The Forex Carry Trade

Traders buying a currency with low-interest rates and selling one with high-interest rates are undertaking a “carry trade.” Before the zero-to-near-zero interest rate environment ushered in by the 2008 global financial crisis, carry trading was a popular Forex trading strategy. A carry trader would go long of a currency with a very high interest rate against a currency with a very low interest rate and keep pocketing the swap paid every day, hoping that the price would not move far enough adversely to wipe out the profit of the swap payments.

A carry trade is still possible today but would have to involve exotic currency pairs or crosses, where spreads are high, and volatility tends to be high enough to wipe out and carry trading profit extremely quickly. Therefore, the strategy lost its appeal as rewards do not justify the risks.

Are Brokers Honest with Forex Swaps?

Some brokers take a fair approach towards overnight swap rates, but most inflate swap fees charged to improve their profits, as the fee is paid by the trader to the broker. They tend to charge traders excessive rates which frankly are not justified by the interbank tom/next fees upon which they are at least theoretically based.

How Can I Find a Forex Swap Fee?

Below is a quick guide to finding Forex swaps in your trading platforms:

1. MT4/MT5 traders can access swap rates from their platform by following these steps:

  1. Right-click on the desired symbol in the Market Watch window and select Specification.

  2. Scroll down until you see Swap Long and Swap Short.

2. cTrader users can access swap rates from their deal ticket as follows:

  1. Right-click on the desired symbol and then select Create New Order.

  2. Click on the symbol to the left of the currency pair.

  1. Scroll down until you see Swap Long (Pips) and Swap Short (Pips).

What about proprietary trading platforms?

Forex brokers who deploy proprietary trading platforms should provide the applicable Forex swaps in their deal ticket. The best Forex brokers will maintain a Forex swaps list on their website, allowing traders to evaluate the Forex trading costs before opening a trading account.

What influences Forex swap rates?

  • The interest rates set by central banks for the base and quote currencies.

  • Internal mark-ups by brokers.

  • The Tom/Next rate set by the interbank markets.

  • The duration of the trade.

  • The size of the position.

Bottom Line

The swap rate quoted by a broker can be easily interpreted by using the table below:

Trade Direction

Positive Number

Negative Number

Long

Number of pips you will PAY each day

Number of pips you will BE PAID each day

Short

Number of pips you will BE PAID each day

Number of pips you will PAY each day

It is common for a typical swap fee to be between 0.5 and 1 pips per day. This means that if you hold a trade open for one week, you are likely to be charged between 4 and 7 pips which will be a trading cost to your account. The cash amount charged to your account will depend upon the position size of your trade. For example, as a pip represents $10 of most standard lots of currency, you would pay between $40 and $70 in this case.

The best Forex brokers will forward earnings from tom/next swap rates to traders, but most fail to do so. They levy internal mark-ups to prevent Forex traders from earning profits from Forex swaps. The easiest way to spot Forex swap manipulation by Forex brokers is to look at the swap rate applied to being long of a currency which has a significantly higher interest rate against another currency which has a significantly lower interest rate.

For example, at the time of writing, the New Zealand Dollar has an interest rate of 0.75%, which the Swiss Franc has a negative interest rate of -0.75%. We might therefore expect that a long position in NZD/CHF should pay a positive swap. If your broker shows a negative swap under these conditions, they are engaged in an excessive mark up for their own profit.

Forex traders must remember that the swap long and swap short rates differ. On long trades, positive swaps are charged, while in short trades, negative swaps are charged.

FAQs

What is swap in Forex?

A swap in Forex is the daily financing cost or payment on an open position charged or paid by a Forex broker.

How does swap work in Forex?

Traders either pay or earn the Forex swap, depending on the interest rate differential between the base and quote currency and the direction of the trade.

What is an example of a swap in Forex?

A trader buying a leveraged EUR/USD position and holding it overnight will pay the Forex swap, while a trader selling it will earn it. Regrettably, most Forex brokers fail to pass on earnings, masking their manipulation by internal mark-ups to eradicate Forex swap profits.

Adam Lemon

Adam Lemon began his role at DailyForex in 2013 when he was brought in as an in-house Chief Analyst. Adam trades Forex, stocks and other instruments in his own account. Adam believes that it is very possible for retail traders/investors to secure a positive return over time provided they limit their risks, follow trends, and persevere through short-term losing streaks – provided only reputable brokerages are used. He has previously worked within financial markets over a 12-year period, including 6 years with Merrill Lynch.
Learn more from Adam in his free lessons at FX Academy

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