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Swap and Rollover in Forex Trading Explained
You’ve probably heard the terms swap and rollover before, but to make sense of these forex trading terms you first need to understand how currency trades work and the concept of interest involved. Each world currency has an interest rate connected to it. Since each forex trade involves two different currencies, it also involves two different interest rates. When you hold an open overnight position, interest is earned or charged depending on the interest rate difference between the two currencies you’re holding. A swap, then, arises due to the overnight interest rates for each currency being different.
What is a Swap in Forex?
Now that you know about interest and the concept of overnight positions, it’s easier to understand that swap (or the swap rate to be more exact) is the overnight rate paid or deducted on an open position. So how does swap relate to rollover? They’re very closely connected terms and are sometimes used interchangeably, but to learn more about the rollover process in-depth read below.
What is a Rollover in Forex?
Rollover is an important concept in forex trading, and one that you should be familiar with if you wish to use more advanced trading strategies. Simply put, rollover is the process of delaying the settlement date of an open trade position. If you trade forex on a ‘spot’ basis, all trades settle two business days from inception, as per market convention. The settlement date is referred to as the value date. This is where rollover comes in. By rolling over the position the trader essentially extends the settlement period by another day. The mechanics of it work by simultaneously closing the existing position at the daily close rate and re-entering at the new opening rate on the next trading day.
EGM Securities offers "rolling spot" forex. This means we don't arrange physical delivery of currencies/precious metals, hence all positions left open from 23:59:45 to 23:59:59 (server time) will be rolled over to a new value date. As a result, positions are subject to a swap charge or credit. Please read our rollover/interest policy to find out more.
Interest and Charges in Rollover Trades
Since many traders don’t have the intention of taking actual delivery of the currency they buy, but rather want to profit from fluctuations in the exchange rates, rollover is a useful trading method in forex. And since each currency trade is done by borrowing one country’s currency to buy another, you can be receiving or having to pay interest. At every trading day’s close, a trader who entered a long position in a high yielding currency relative to the currency they borrowed will receive a certain amount of interest on their account. On the opposite side, a trader will need to pay interest the currency they borrowed has a higher interest rate relative to the currency they purchased. Traders that don’t want to collect or pay interest would need to close out their positions by the end of the trading day.
The rollover cost is based on the interest rate differential of the two currencies. Let’s assume that the interest rates in the EU and USA are 4.25% and 3.5% per annum respectively. As mentioned earlier, every currency trade involves borrowing one currency to buy another. If you have a buy position of 1.0 lot in EURUSD, then you earn 4.25% on your euros and borrow US dollars at a rate of 3.5% per year.
Take a look at these examples to better understand how this concept applies in various scenarios:
- If you have a long position (buy) and the first currency in the currency pair has a higher overnight interest rate than the second currency, you receive a gain.
- If you have a short position (sell) and the first currency in the currency pair has a higher overnight interest rate than the second currency, you lose the difference.
- If you have a long position and the first currency in the currency pair has a lower overnight interest rate than the second currency, you lose the difference.
- If you have a short position and the first currency in the currency pair has a lower overnight interest rate than the second currency, you receive a gain.
Please note that the interest earned or paid by a US-based currency trader during these forex trades is regarded by the IRS as ordinary interest income or expense. For tax purposes, you should keep track of any interest received or paid, which is separate from regular trading gains and losses that you report.
- If you open and close a position before 23:59:45 (MetaTrader time, EET), you will not be subject to a rollover.
- The act of rolling the currency pair over is known as tom.next, which stands for tomorrow and the next day.
- When you roll an open position from Wednesday to Thursday, Monday next week becomes the value date, not Saturday; therefore the rollover charge on a Wednesday evening will be three times the value indicated on the rollover/interest policy page.
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