It’s not unknown for Forex traders that the position transfer to the next day is called swap. And in this connection traders should be well aware that depending on the interest rate differential between the two currencies included in the transaction the company pays or charges certain amount.
While making a deal to buy or sell a currency the parties commit themselves to make final payments on the day known as Value Date. The settlement is realized within 2 working days after the transaction.
In case the position remains open rolling over to the next day this signifies transference of the value date to a day ahead. The volumes of currencies which are included in transaction are lent and borrowed in the interbank market at deposit and credit interest rates.
Costs of borrowing and gains from lending are transferred to the client. How is this done? Either the position is re-opened automatically at a new, adjusted to price, swap, and a new value date, or it is left with the previous price, though the swap is deducted from or credited to the client’s account.
The cost of the rollover is in direct connection with the interest rate differential between the two currencies of the transaction and therefore depends on it. Because of the difference between deposit and credit rates of the same currency the costs of rolling long and short positions on the same currency pair are different.
What is beneficial for trader? The lower is the rate for the currency sold and the higher is the rate for the currency bought the more beneficial the position rollover will be.
Swap conditions vary from company to company as sometimes the cost of the position rollover on the same trading instrument is different. If the position is transferred to a day ahead we deal with Overnight Rates that reflect the current situation in the money market providing the client with the most favorable Swap conditions.
In case the company stands away from the higher levels of the market hierarchy the cost of the rollover gets worse for the clients. This is because each level adds its own interest to rollover costs. Therefore, Swap Rates tend to differ from the interbank rates.
There exist such companies which provide trading services and while calculating Swaps set the interest as a fixed percentage. This worsens the terms for a trader.
The distinction between Swaps for Long and Short Positions is also essential while analyzing Swap operations. Greater difference signifies greater interest as the spread between overnight deposit and credit rates is usually low in the interbank market, particularly for liquid currencies.
Traders have a chance to perform a swap operation once a day, so that the terms of rollover are essential if one wants to open and hold positions for a long time concentrating on more continuous movements and not on intraday price movements.
Moreover, if the trader applies the strategies of “Carry Trade” swap conditions become of great importance for him. These strategies are based precisely on the interest rate differential between currencies, together with depositing in a currency with a higher rate and borrowing in a currency with a lower rate.
Another feature that traders give importance is the case of lock mode hedging. To understand this let’s imagine a situation that a trader opens a position expecting some changes in the market which has not started yet. He is likely to hedge the position by opening the opposite one. The cost of maintaining such positions will be minimized by the low spread between the rates as ensured by the “Interbank” Swap.