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Forex swap, also known as a foreign currency swap, is a type of interest rate that an investor pays or receives after trading. This concept is commonly misunderstood by traders, however, it’s very important to know how the swap works in the Forex trading market because it might have a big influence on the potential income.
Sometimes traders wish to generate a big amount of profit, however, they can’t afford large deposits. This is when the leverage tool is used. That way they have an opportunity to increase their trading positions, so they borrow funds and deposit a small amount of money in order to gain a big profit in return. As this offer actually is a loan, it requires an interest rate that investors will pay or receive. This specific interest rate is called a swap in Forex trading.
There are different kinds of swap values: negative and positive. According to the swap value you either receive or pay the required interest rate. Usually, when investors begin to trade in the Forex market they buy one currency and sell the other one. Each currency has its own interest rate, the latter is determined by the Central Bank. The difference between those interest rates is called carry.
Usually, traders can high amount of profits when they use the leverage tool while trading. Very few people are so well-funded that they can make a huge deposit. So using small deposits in order to generate a big payout is a very common thing in the Forex market. This means that understanding the exact meaning of swap and how it works is very essential for each investor who wants to be successful in the Forex market.
In this guide, we will analyze everything related to the swap concept, including how it is calculated, how it works, and what are the main features of the swap in the Forex market that one should definitely consider before trading.
How to Make Money With the Forex Swap
The people who want to gain profit with the swap tool are called carry traders. First of all, one should choose the currency they are wishing to trade with. The important feature while selecting the currency is that it should have a high-interest rate compared to the one it is paired with. This means that an investor should find the currency with a low-interest rate and then match it with the one he is buying.
After selecting the currency pair, traders need to wait when it will trend down. The noticeable feature is that profit is generated by a swap tool with the interest rate difference. However, this difference should be positive, not negative.
Besides, traders need to know that market performance is constantly changing, which means that currencies are also very variable. This highlights the fact that if an investment is attractive in the Forex market at the given moment, it doesn’t mean that it will always be the same way. so this change always should be considered while selecting the currencies and trading with them.
Forex swap meaning might seem a little complicated and confusing for some people, however, once they realize the main idea behind it and how does it work, it is a great chance that it will become easier to generate profit with this tool.
Besides, investors should also know that swaps occur only when they open positions for more than one day. This means that if one opened the position for only one day, he will not pay the interest rate at all. Swap only starts to activate after the account is left open for more than a day. The number of interest rates that one is charged with or receives is depended on the central bank. So the amount of swap is not fixed as it is a variable number.
It is important to remember that several factors influence making money with the Forex swap including the difference between the number of interest rates of certain currencies, the number of days when an investor opens the position, individual broker’s commission rates, currency price movements, and so on.
However, as in any kind of trade, swap trade also includes some risk in itself. The main risk about trading with the swap is for those who open and close their trading position on the same day. That way people don’t pay for the interest rate and the risk to gain only the money they’ve traded. But those risks make the trading process less boring, this is why a lot of investors think that sometimes you’d better risk in order to become successful.
How Can You Calculate the Swap Rate?
There are several ways of how to calculate swap in Forex. In many cases, this process is complicated and confusing, however, it is a very important part of trading with this tool. sometimes people use trading calculators in order to make the calculating process easier and to avoid misunderstandings.
It is essential to note that the swap rate is different for every broker and an investor can find out the exact amount from the contract specification page. The swap rate needs to be calculated in the nominal value, however, sometimes some broker might tell you their rate as an annual percentage. This process might seem a little hard and puzzling but when you catch the main logic, everything will get clear soon.
Besides, one should remember that the number of swaps changes according to the trading instrument. As we have already discussed, the rate of the swap might be both, positive and negative and it depends on the traders’ position. This means that if the overall number is negative, you will be charged with the interest rate, however, if it’s positive, you will be paid for it instead. Several factors affect this mentioning process including the lot size, the Forex market price, as well as the amount of the differential between the two swap rates of the currencies at the given time.
Specific Examples of the FX Swap
Sometimes the meaning of the swap tool is misunderstood by a lot of traders. This is why it is important to take good real-life examples that clarify the main purpose of trading with the FX swap. So let’s talk about these swaps in Forex examples. Let’s suppose that an investor bought euros and sold Japanese yen. This will be the currency EUR/USD pairs with the worth of 100,000 units.
According to the swap calculator Swap equals (position × (interest difference – commission) / 100) × price / days per year.
Let’s suppose the EUR/USD asking price is 118.24, the interest rate of EUR is 4.16%, and the interest rate of USD is 3.6%. This means that we have almost every variable to receive a final number of the swap rate. A position size (100,000 USD), a price of the currency pair (118.24), the difference between interest rates (4.16-3.6=0.56%), the broker’s commission (let’s suppose the percentage of 0.12%), and at last, the number of days in a year (365).
So, for this mentioned example, the final rate of the swap will be: (100,000 x (0.56 – 0.12) / 100) x 118.24 / 365 (USD).
This is the amount of money that will be added to the investor’s account.
However, If one is selling the euros and buying the U.S Dollars it will look like this:
(100,000 x (0.56 + 0.12) / 100) x 118.24 / 365 (USD).
This means that the investor will have to pay the final amount that will be resulted from this equation.
This real life example might be helpful for some new investors who don’t know the exact meaning of the Swap tool and how does it work in Forex trading.
Other Important Features of the FX Swap
First of all, it is important to note that there are several differences in short and long-run trading. This time difference can affect a great deal of the potential profit that the trader will be able to generate. For example, if one is trading in a short period of time, then the interest rate will have a small effect on their final wealth. The same logic goes with the long-run traders for whom the Forex swap rate impact on the overall payout will be substantial. However, the latter type of traders also needs to be more attentive in the trading processes with the FX swap.
Besides, there are a lot of people who are very confused about the things mentioned above, so they often ask whether there is a trading account without a swap or not. The answer to this question is positive as there truly are some account that doesn’t require using swap tool. For example, this type of account includes Islamic accounts. However, this fact has its own reason. In the Islamic world, traders are not allowed to pay interest rates, so this account has some additional rules and fees that are not usual for the other accounts. The good thing is that almost every brokerage has Islamic accounts on its list.
Final Words
In this article, we have already discussed the Forex swap meaning which states that this is the type of interest rate one pays or is paid according to the trading position. This tool is one of the most puzzling and confusing things in the Forex market, this is why a lot of investors don’t understand how it works and how to use it properly. So we tried to clarify these things a little bit and analyzed above almost all of the features this tool has.
So as we have already mentioned, Swap in the Forex market is very important and can have a big influence on the overall profit of the trader. In the process of trading with the Forex swap, one needs to consider the fact that choosing the right currency is essential. while selecting the currency, one needs to know that it should have a high-interest rate compared to the one it is paired with.
Besides, the major factors that should be considered while making money with the swap tool are the difference between the number of interest rates of certain currencies, the number of days when an investor opens the position, individual broker’s commission rates and etc.
However, Swap trade also involves some risks so new investors are recommended to look closely at the main features of this tool including how it is calculated and how it can affect the final number of profits. That way they can minimize those risks and maximize the potential payout they will generate in the future.