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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 (first-named currency), with profit or loss made in the quote currency (second-named currency). In effect, you agree with us as the counterparty to take a view in one currency before swapping it back at a date of your choosing, with any running profits or losses cash-adjusted to the account.

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're trading isn't the only price you need to watch; you should also be aware of the swap or funding charge.

The swap charge is heavily influenced by the underlying interest rate corresponding to each of the two currencies involved. The swap charge is applied should 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.'

Intraday traders won't need to worry about swap charges, as they'll naturally close their positions before the daily rollover point. But for anyone else holding a position overnight or longer, you need to consider this in your trading considerations.

How is rollover interest calculated?

Swap charges are driven by interest rate differentials. Interest rate differentials are another way of thinking about the difference in interest rates between your base and quote currencies. Naturally, 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. Factors that affect this amount include lot size, the current market price, and the extent of the differential between the two interest rates at that time. This differential forms the basis of the carry trade.

What is a carry trade?

When the market conditions suit, traders will often 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, then net off the positive interest differential. This is known as the carry trade, with the trader carrying over their position to pick up the interest and the swap rate differential. Carry is a huge part of the FX landscape and can be a primary consideration for many hedge funds.

Why do brokers charge swaps?

At Pepperstone, we offer our clients the ability to actively trade price changes in the global currency markets without having any interest in taking physical delivery of the traded currency. So when we enter a leveraged FX position, it’s on an open-ended, rolling settlement basis. What this means is, 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). If an institution buys EURUSD in the spot FX market, they’ll receive EURs at the agreed rate two days after the day of the trade. 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. Their rate fluctuates with monetary policy expectations as well as other market forces, such as supply, demand, and liquidity that affect the market. Institutions often look to delay settlements by entering into a tom next arrangement.

Example of a tom next swap

Let’s say a trader buys one contract (€100,000 notional) of EURUSD, but for whatever reason wants to delay settlement by a day. The following day, the counterparty swaps the €100,000 back to the trader for the 'next' day at the previous transaction rate plus the additional tom next market rate. The result being settlement is pushed back by a day, with the trader’s transacted exchange rate now adjusted for the market tom next rate.

We replicate this exact process due to the way we manage our client flow with our hedging banks. This means the cost (or credit) of rollover and delaying settlement is replicated to your account. Should you decide to hold a position past the set rollover time of 5 pm New York time (or 7am AEST), you’ll pay or earn the tom next charge on your nominal position inclusive of any profits or losses.

Note that in the physical FX world, the previously agreed opening price is adjusted for the swap rate. In leveraged FX trading, which is what we offer, there’s a simple cash adjustment to your account.

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)

For example:

Currency pair: EURUSD

One point: 0.00001

Account base: EUR

Exchange rate: 1.1290

Trade size: 1 lot (€100,000)

Pepperstone’s long swap rate: -11.49, short swap rate: +7.02

Swap value to be debited from the account: (0.00001/1.1290) * (100,000 *-11.49) = €-10.18

If you were short one contract of EURUSD, you’d receive €6.22 a day.

What is a triple swap?

A three-day rollover is an industry standard. While traders will be charged (or credited) the tom next rate for one day if they hold past 5pm New York time, the most confusing and misunderstood part of the rollover charge is the three-day rollover charge, also known as triple swap Wednesday.

This is because 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.

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.

Stay ahead of the trade

When trading forex, it’s not just your P&L you need to watch. Swap charges can help or hinder your account depending on the currencies you’re trading and the interest rate differentials. It’s important to know what rollovers are and how they’re applied to your account, as well as common pitfalls for traders holding overnight positions. For more information on how to calculate tom next, triple swap Wednesdays or how to make the most of managing your account when holding your position overnight, get in touch with us.

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