Everyone trading on the exchange must know and understand what a swap is. In my rather long prof...
Everyone trading on the exchange must know and understand what a swap is. In my rather long professional career, I have come across many situations where people lost entire deposits simply because they didn’t know how swaps worked.
In other words, if you understand well what swap is and how it works, you can protect yourself from unnecessary losses and even use swaps for additional profit. This concept is as important as leverage.
Now let's figure out what fx swap is.
A foreign exchange swap is the difference in the interest rates of the banks issuing the two currencies, which is credited to or charged from the account when the trading position is kept overnight.
The central banks of each country determine the key interest rate. This is the rate at which the central bank lends to other banks.
This rate may change throughout the year. But its starting value is determined at the first meeting of the central bank of the year.
On the foreign exchange market currency pairs are traded. Two different currencies are involved in the transaction, and each of them has its own interest rate.
The currency pair contains the base and the quote currency. The former is the currency we buy and the latter is the currency we buy it with.
The base currency is also called the deposit currency. This is our currency and the exchange uses it on a daily basis. Therefore it must pay us a certain percentage for it.
The quote currency is also called the counter currency. It belongs to the bank and we borrow it from the bank. Therefore we pay interest to the bank for the use of its currency, like with a consumer loan.
A swap is negative when you pay it or positive when it is paid to you.
If there is a negative swap (with a minus sign), it's crediting to your trading account will end when you withdraw the funds (points).
If the difference in the interest rates gives a positive swap, the money will not be withdrawn from your account, but rather a certain number of points will be credited.
Thus, if the client has an open position at the close of the New York trading session, a currency swap operation is enforced. This means the position is simultaneously closed and opened for the new day.
But on the client's account, there is no actual closing and opening. Rather the credited or charged interest is simply displayed.
However, there is a day when this operation is tripled. This is called a triple swap day. For forex currency pairs, this is Wednesday to Thursday night.
This is because settlements on the exchange for a position open on Wednesday are made on Friday.
Therefore, the calculations for the position carried over from Wednesday to Thursday are done for the next day. And the next business day after Friday is Monday. This adds up to 3 days.
Swap in trading is different for each instrument. It wouldn’t be convenient to constantly calculate them, so brokers provide special swap tables. My broker has a swap table you can use here.
How to Calculate Swap In Forex?
In order to understand when we pay swap and when it is paid to us, let's talk about how is swap calculated in forex when buying or selling:
There is a simple formula, as shown above. The most important parameter of this formula is the rates of the central banks, or rather the difference in the interest rates of the base and quote currencies.
For example, let’s compare rates for the EURUSD currency pair. The ECB rate is now at 0% (loans are effectively free), and the Fed rate is set at 0.25%.
So if we buy a currency pair, we must subtract the quote currency rate from the base currency rate: 0 - 0.25 = -0.25. This means when buying this pair, the difference in rates is negative, and therefore the swap will be negative.
But when selling a pair, on the contrary, we need to subtract the base currency from the quote currency: 0.25 - 0 = 0.25. The swap will be positive.
This operation only gives us the positive or negative sign of the swap (which means either you pay or get paid). If we want to calculate the swap value itself, we need to substitute all the values into the formula.
FX Swaps and Cross Currency Swaps: As I said above, there are several types of swaps. Now let's take a look at the difference between the three main types of swaps.
Forex Swap
Fx swap is the difference between the interest rates of the banks of the two currencies in a pair, which is credited or charged when an open position is carried overnight. (Continue reading with LiteFinance)
