Posts Tagged ‘swap-free’

Do Swaps Make Sense?

Tuesday, May 8th, 2012

The easiest definition of swap term is assets retained or added to a trading account for prolongation (carry over) of a position to the next day or a fee for carrying a position over midnight.

moneySwaps can be either positive or negative. Interest for a position carry over in a currency market is paid or deducted for every open trade at 17.00 EST (Eastern Standard Time) for every trading day. Trades opened before 17.00 EST and retained after this time are considered as carried over till next day and are charged or credited with an interest depending on a trading position opened by trader.

The currency of one country bought/sold by trader versus the one of another determines if it is going to be positive or negative swap. The swap rates are set by currency rates composing a currency pair. In case the loan rate exceeds the deposit one, the swap is written off from a trading account. Positive swap is credited when the active rate of bought currency is higher than the one of sold currency.

The target of Forex traders is to derive profit running speculative operations with currency contracts. Practically, a currency delivery does not take place. Working through a brokerage company, trader may apply to leverage and hold positions open for as long as he wants. In case a factual currency delivery is expected, it should have been accomplished within 2 days.

In most cases a position carrying over to the next day is implemented automatically by broker. It is required for prolongation of a current open position and avoiding a real accrual of purchased currency to a trading account. Swap combines with buying or selling of two contracts with different settlement dates on equal terms. If a position remains open by the end of the day, it will be closed and opened immediately, but with a small gap. During trade execution a currency purchased by trader is conditionally deposited into bank at interest, and the sold currency is taken as a loan at interest rate as well. For instance, you open a trade with USD/JPY pair, buying dollars for yens. In case at that time the interest rate in the USA is higher (for example, at 1%) than in Japan (0.3%), then you will have the difference between them (0.7%) accrued. If you would sell dollars buying yens, then you would have to pay the difference between the rates.

From Wednesday to Thursday a triple swap is added or deducted. Why? As trade calculations and currency delivery would have been completed on the second day (in our case it is Saturday), when world banks are closed, the settlement date shifts to Monday and the swap is calculated for 3 days.

Positive swaps allow trader to raise additional profit. Currencies with huge interest rate difference are actively applied in carry trade operations for gaining only due to rate fluctuations and swaps.

Some brokers provide their customers with swap-free accounts, if standard trading terms run counter to their religious convictions. On swap-free accounts (also called Islamic) any currency pair trades can be executed, but if they are carried over midnight, trader gets no profit or loss.

Added by Andrey Misyuk,
InstaForex Clients’ relationship manager