FOREX TRADING TUTORIAL BY DEDE E. ADJANKE (WHAT SWAP IN FOREX AND HOW DO WE CALCULATE IT ?)

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WHAT IS SWAP IN FOREX AND HOW DO WE CALCULATE IT ?

 

SWAP is an interest fee that is either paid or charged to you at the end of each trading day. When trading on margin, you receive interest on your long positions, while paying interest on short positions. The net interest difference is known as the carry and traders seeking to profit from this are known as carry traders.

Positive carry results when you receive more in interest than you are required to pay, and is added directly to your account. If the carry is negative, it is subtracted from your account. If you open and close a trade within the same day, the trade has no interest implications.

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Can I make money from swap in Forex trading?

If you’re interested in placing a carry trade, the first step is finding a high yielding and low yielding forex currency pair. Some examples of low yielding (or funding currencies) are the Japanese Yen (JPY), the Swiss Franc (CHF) and the Euro (EUR). As far as high yielding currencies go, the Australian Dollar (AUD) and New Zealand Dollar (NZD) are popular, though more advanced carry traders might look to the South African Rand (ZAR) or other exotic currencies.

Let’s use the Euro and Australian Dollar: rates in the Eurozone are currently below 0, whilst interest rates in Australia are relatively higher, currently 2%. This means that there is an opportunity to earn carry buying AUD with EUR ie going short EURAUD. Great, simple right?

Sadly it’s not that easy there is no point earning a pip a day in swap if the pair is moving against you 100 pips / week. That is, if we wanted to perform a carry trade on EURAUD, we would wait until the pair was trending down, sell into any strength and hold for the length of the down trend.

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How to calculate SWAP

In the examples below, we’ll show you how to calculate the amount that will be credited or charged, factoring in only the interest rates and the broker’s commission, but in reality, the “storage” for holding a position overnight may depend on a variety of factors:

  • The current interest rates in the two countries
  • The price movement of the currency pair
  • The behavior of the forward market
  • The swap points of the broker’s counter-party

Here’s what we mean when we say storage depends on interest rates:

Let’s say that the interest rate of the European Central Bank (ECB) is 4.25% and the Fed (US) interest rate is 3.5%. You open a short position (Sell) on EURUSD for 1 lot. Here, you are essentially selling 100,000 EUR, borrowing at a rate of 4.25%. In selling EURUSD, you are buying US Dollars, which earn interest at a rate of 3.5%. When the interest rate of the country whose currency you are buying is more than the interest rate of the country whose currency you are selling, storage will be added to your trading account (this may not always hold true, as brokers often charge a fee or markup for overnight swaps). If the interest rate is higher in the country whose currency you are selling, as is the case in this example (4.25 > 3.5), storage will be deducted from your account.

Now let’s say the broker charges an extra 0.25% for the swap. Add this to the 0.75% difference in the interest rates and you get 1.00%. For the position described above, the storage you will be charged will be equivalent to being charged 1.00% interest.

  • Calculating the swap on a short position: Here we are buying USD and selling EUR. Since the interest rate of the currency we are selling (EUR: 4.25%) is higher than that of the currency we are buying (USD: 3.5%), we will add the Markup in the formula:

SWAP = (Contract × (InterestRateDifferential + Markup) / 100) × Рrice / DaysPerYear

  • Contract: 100,000 EUR (1 lot)
  • Рrice: EURUSD – 1.3500
  • InterestRateDifferential: 0.75% (the difference between the interest rates in Europe and the US)
  • Markup: 0.25% (the broker’s commission)
  • DaysPerYear: 365 (number of days in a year)

Calculation

  1. SWAP = (100,000 × (0.75 + 0.25) / 100) × 1.3500 / 365 = 3.70 USD

When your short position on EURUSD is rolled over to the next day, 3.70 USD will be debited from your trading account for storage.

  • Calculating the swap on a long position: When we buy EURUSD, we are buying EUR and selling USD. Since the interest rate of the currency we are buying (EUR: 4.25%) is higher than that of the currency we are selling (USD: 3.5%), we will subtract the Markup in the formula:

SWAP = (Contract × (InterestRateDifferential – Markup) / 100) × Рrice / DaysPerYear

  1. SWAP = (100,000 × (0.75 – 0.25) / 100) × 1.3500 / 365 = 1.85 USD

When your long position on EURUSD is rolled over to the next day, 1.85 USD will be credited to your trading account.

Please Note: When the difference between the interest rates is smaller than the broker’s commission, you will be charged storage for both Buy and Sell orders.

Sometimes you have to look at the time session you place your trade ,you might place a trade the same day and will charge for a positive or negative swap .If you are considering holding a trade for long ,always have the right set up and check the swap and also consider the type of Broker(Some Brokers swap and Spread are very high ) you are dealing with .

By Dede Elorm ADJANKE

(Business Development Team Leader )

For more information about this tutorials

Call (233)302906626

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