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  5. What are swaps in forex and how are they calculated?

What are swaps in forex and how are they calculated?

What are swaps in forex and how are they calculated?

When you trade forex, you express a view on the direction of a currency pair by buying or selling the base currency.

Holding a position depends on your trading strategy and plan. Swing traders might hold a position for days or even weeks, while scalpers might hold it for a few seconds. When holding a position, the price of the currency pair you are trading is not the only price you need to watch; you should also be aware of the swap or funding charge.

The swap charge is applied if you hold the position at the daily rollover point, which is 00:00 server time and known in forex trading as ‘tomorrow next’ or ‘tom next.’

How is rollover interest calculated?

Swap charges are driven by interest rate differentials (the difference in interest rates between your base and quote currencies). There can be differences in the two interest rates, so when we net these off and assess the differential, you could be charged — or even receive — a daily amount of interest. This differential forms the basis of the carry trade.

What is a carry trade?

Carry trade happens when traders actively take a position in a currency with the higher corresponding interest rate, as well as ‘fund’ the trade by shorting a currency with a lower interest rate, and then net off the positive interest differential.

Why do brokers charge swaps?

As a trader you decide when you want to close a position using a stop-loss or other form of trade management, and brokers as the counterparty use the rollover time to calculate funding charges in lieu of delivery or receipt of physical currency.

How does settlement take place in the underlying FX spot market?

In the underlying market, spot FX transactions tend to settle two business days after the trade date (T+2). There are some exceptions to this rule, for example, USDCAD, which settles the day after the trade (T+1).

What is tom next?

Tom next swaps are fully tradable financial instruments. Basically, tom next is used when a trader wants to delay settlement. If you decide to hold a position past the set rollover time of 5 pm New York time (or 7am AEST), you will pay or earn the tom next charge on your nominal position inclusive of any profits or losses.

How do we source our tom next rates?

We source our tom next rates from a tier-one global investment bank. These are updated on a regular basis to account for the dynamic tom next market.

Daily swap charge / credit = (One point / exchange rate) * (Trade size [or notional amount] * tom next charge)

What is a triple swap?

If a trader holds a position past 5pm New York time on Wednesday, the trade will be treated as having been executed on Thursday and the account will be adjusted for three days of interest. This is known as three-day rollover charge or triple swap Wednesday.

Given the T+2 nature of the settlement, the settlement date the broker is exposed to is pushed out to Monday, which means the trader will be charged (or credited) for funding for both days of the weekend. Even though the FX markets are closed, the three-day tom next exposure is treated in calendar days.

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