Swap in forex trading means the interest charged for trades that are kept open at the end of the trading day.
When you use leverage in your trading, you are actually borrowing from a broker and depositing a smaller amount of your assets. Like all loans, this loan also includes interest, which the trader must pay or receive according to his trade. This interest rate is known as swap. In reality, this interest rate does not belong to the broker and is paid directly to the bank.
The concept of swap in simple language
The interest rate is determined by the central banks of each country. This rate is the rate that the central bank lends to other banks and may change throughout the year. But its initial amount is determined in the first meeting of the Central Bank in the year.
In the forex market, currency pairs are traded, which include two different currencies and each has its own interest rate.
Currency pairs include the base currency and the quote currency. The base currency is the currency that is purchased and the quote currency is the currency that the base currency is purchased with.
A negative swap is when it is paid and a positive swap is when this amount is paid to you.
If the swap is negative, its amount will be deducted from your account after closing the transaction. If the difference in interest rates results in a positive swap, money will not be withdrawn from your trading account, but a certain amount will be credited to your account.
Therefore, if the client has an open position at the end of the New York trading session, the swap operation is executed with currencies. This means that the position is simultaneously closed and opened for the new day. But in the client’s trading account, there is no real closing and opening. Rather, only deposited or charged interest is displayed.
However, there is a day when the value of this operation triples. This is because the settlements for a position open on Wednesday are settled on Friday. Therefore, the calculations for the position transferred from Wednesday to Thursday are carried out for the following working day. And the working day after Friday is Monday. This triples the weekend swap fees.
Types of swaps in forex
When a position is held open after the trading session has ended, two types of swaps may occur:
- Long Swap: This occurs when a trader keeps a long position open after the session is over. If the currency bought has a higher interest rate than the currency sold, the trader may receive a profit. On the contrary, if the interest rate of the purchased currency is lower, the trader is obliged to pay interest. This aspect is very important for traders who hold their positions for a long period of time.
- This applies to traders who keep a short position open after the session ends. In this case, the interest rate adjustment is based on the currency that is sold. If the interest rate of the currency sold is lower than the interest rate of the currency bought, the swap is deducted from the trader. But if the interest rate of the currency sold is higher, the trader may be paid a profit.
Swap calculation
The formula for calculating forex swaps is relatively simple:
Swap = (pip value x swap rate x number of nights)/10
This formula helps traders estimate the swap cost of keeping a trade open overnight.
Example:
Let’s look at a practical example. Let’s say a forex trader trades the EUR/USD currency pair with a long position of 1 lot and the swap rate is -0.25 pips. If the pip value is $10 and the trader holds the position overnight, the swap fee will be calculated as follows:
Swap cost = (10 × -0.25 × 1)/10 = 0.25 dollars
In this case, the forex trader will pay 25 cents to hold the position overnight. This example shows how swaps can affect your trading costs even by small amounts.
The impact of swaps on forex trading
In forex trading, the impact of swaps varies significantly based on the duration of the trade:
Short-term trades: For trades that are open for less than a week, swaps usually have little effect on the overall profit or loss. This is due to the short-term exposure to interest rate differentials.
Long-term trades: Conversely, for swing trades or long-term positions that are held open for weeks or months, swaps become a critical factor.
Management of swaps in Forex
To effectively manage forex swaps, focus on strategic trading and broker selection, be aware of interest rate differentials, and for short-term trades, close trades before the end of the session to avoid swap fees. Also, choose a broker that offers favorable swap rates and consider accounts with low or zero swap rates, such as Islamic accounts, for your long-term trading.
In this regard, MondFX is a forex and CFD broker that offers its services to a wide range of traders, including Muslim traders. This broker is one of the few brokers that offers an Islamic account with zero swap rate to its customers.
Some of the general features of MondFX are:
– Presentation of the MetaTrader 5 trading platform
– Wide range of trading instruments including forex currency pairs, precious metals, indices and stocks
– Various trading accounts to meet the needs of different traders
– Customer support in Farsi language
– Tutorials and educational resources to help traders improve their skills
Frequently asked questions
What is a swap in Forex?
A forex swap is a fee paid or charged to hold a trading position overnight in the currency market. This fee is actually an interest payment that represents the cost or profit of holding a trade until the next trading day. This cost is determined based on the interest rate difference between two currencies in the trading currency pair.
How do swaps work in Forex?
In Forex, swaps act as a mechanism to adjust the interest rate difference between two currencies in a traded financial instrument. When you hold a trading position overnight, the swap is either credited or deducted from your trading account based on this interest rate differential.
How to avoid swaps in forex?
The way to avoid swap fees in Forex is simple: close all your trading positions before the end of the trading session. If you want to keep the transaction open and do long-term transactions, it is recommended to use Islamic accounts where swap is zero.
Does the base currency affect the swap?
Yes, the base currency affects the swap in forex trading. Swap rates depend on the interest rate difference between the base currency and the quote currency. A higher interest rate for the base currency can result in a positive swap in a long position, while a lower rate may result in a negative swap.
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