What is swap?
Forex trading has many nuances that novice traders need to understand well in order to successfully trade with trusted brokers. In this article, we will learn what swap is on the Forex market, how it is formed and credited to a trading account, and also what a swap-free account is.
What is swap?
Since most traders do not have enough of their own funds to trade on the foreign exchange market, they use leverage. That means, they borrow funds from brokers and can deposit only a small part of the total amount.
Borrowed funds are essentially a loan, for which traders must receive or, conversely, pay a certain interest rate when they open long-term positions and leave trades open for more than a day. This process is similar to using bank loans and savings accounts. The borrower pays interest to the bank for using the loan. On the contrary, the bank pays monthly commission to the owner of the savings account.
A swap is the difference in the interest rates of two currencies in a Forex pair, which is either credited to the account or charged from the trader's account when the trading position is transferred to the next day. The interest rate of each national currency is set by the country's central bank.
If the base rate for the currency you’re buying is higher than for the one you’re selling, you will receive an additional swap due to the positive difference between the rates of both currencies. If the interest rate for the sold currency is higher than that of the bought currency, the trader will have to pay the swap to keep the position overnight.
Let's check the following example with USDJPY currency pair. In this pair, USD is the base currency and JPY is the quote currency. The base currency is also called the deposit currency, and the quote currency is called the credit currency. The base currency belongs to the trader and the Forex broker pays certain interest for using this currency in the same way as the bank pays interest to the owners of the savings account. On the contrary, the credit currency belongs to the bank and the clients pay the interest for the use of the currency. It is the same as paying interest for the consumer debt taken from the bank in order to purchase goods and services.
These examples assume that the interest rate for the US dollar is lower than for the Japanese yen.
Let's say a trader opens a long position (buy) on the USDJPY pair, which he does not close until the next day. In this pair, USD is the base currency and JPY is the quote currency. In other words, the trader buys dollars and sells the yen. The trader receives interest for the bought dollars, while he pays interest for the sold yen. Since the interest rate of the dollar is lower than the yen, the trader pays more than he receives. As a result, the negative swap is withdrawn from the trader's account on the next trading day.
Now let's look at a short position. Let's say a trader opens a short position (sell) on the USDJPY pair, which he does not close until the next day. The trader sells dollars to receive the yen. For the dollars sold, the trader pays interest. At the same time he receives interest for the yen. Since the interest rate of the dollar is lower than the yen, the trader gains more than he loses. As a result, a positive swap is credited to the trader's account on the next trading day.
It should be borne in mind that many brokers have a commission for overnight positions, which is usually included in the swap amount. For this reason, the swap can be negative regardless of the type of position. Different brokers charge different commissions. Usually, the amounts of commissions are listed in the specifications of trading instrument contracts on the broker's website or in the trading platform.
When is the swap charged? What is the “triple swap”?
The exact time when the swap is charged from your trading account will depend on your broker. For most brokers, it is charged after midnight and before 01:00 server time. The swap is also charged on weekends. However, since the market itself is closed on these days, the swap is calculated on one of the working days. The so-called “triple swap” is charged or credited to trading accounts on the night from Wednesday to Thursday.
What is an Islamic account (swap-free account)?
Islamic Forex accounts are a type of trading account offered to clients who want to invest in the foreign exchange market while following the principles of the Quran. Since Sharia law prohibits the accumulation and deduction of interest, interest rates including swaps are not charged on Islamic accounts. That is why these accounts are also called “swap-free”.
Instead, Islamic trading accounts may have different trading conditions and commissions such as weekly commissions or commissions charged when trades are opened, although sometimes none are charged. Detailed trading conditions for swap-free accounts are usually indicated on the websites of the Forex brokers that provide them.
Swap is an important component of Forex trading. For traders, it can become a source of income as well as a large expense item. Swap plays an important role in trading strategies aimed at using position rollovers for additional profit. Traders should be well versed in the details of this process or they can suffer additional losses. Those who acquire this particular knowledge can use the process of swap in order to generate additional Forex trading income.
Article last updated: 2022-10-28