By: Charley Warady
The process of trading Forex is not only the buying and selling of currency pairs. It can be this straight forward, of course, and many Forex traders spend their entire careers not knowing or caring about what's involved in a Forex swap. The intricacies of this financial tool is not for the novice. That fact is first and foremost. A majority of experienced Forex traders never trade a Forex swap, but for those that do, it can be most profitable.
First things first
Put into one sentence, a Forex swap is the simultaneous purchase and sale of the same amount of a given currency for two different dates, against the sale and purchase of another. You can see why this might not be attractive to the newbie Forex trader. Basically what you're doing is borrowing one currency while lending another for a specified amount of time. You're locking in two rates.
What happened there?
The Forex swap is when a Forex broker and a trader trade one currency for another at an agreed rate and then convert those currencies back at a selected date in the future at the previously agreed exchange rate. So, as a Forex trader you're making two transactions. The first being made now, and the second being made in the future.
Naturally, the broker has to make his money somehow in this whole deal. As nice as your Forex broker may seem, he is probably no philanthropist. In a Forex swap, the broker makes his money set by the difference in the interest rates of the two selected currencies. The interest which you can earn during the Forex swap period is used by the broker to calculate the price.
Better safe than sorry
The forex swap is actually the simplest form of currency swap. The exchange of the given currencies is based on the current exchange rate. Taking that into account, the two parties give back the original amounts at a later date based on a specified forward rate.
The forward rate locks in the exchange rate at which the funds will be swapped in the future, protecting the Forex traders from any possible fluctuations of interest rates of the respective currencies.
It's hedging. It's done all the time in every market and the Forex market is no different. The complexity of this form of hedging as compared to straight out trading on the software provided by your Forex broker is the reason why it is not recommended for the novice.
However, once you are experienced and educated in the Forex market, it is a useful system and even with the costs involved can prove to be profitable. There are various forms of swaps in all the financial markets and some of them overlap with the Forex market.
Look it up
Like everything else, there is a wealth of information available on the Forex swap on the Internet, and before diving into it, the Forex trader should do his best to become familiar with the ins and outs of the process. There are forums where traders with experience will share their knowledge and it's worth it to join in and even ask questions. Know-how, like currencies...are worth swapping.