If you are one of the beginners of the market, it won’t be a surprise that you are having a very hard time understanding different types of topics in the world of Forex trading. Today, we are going to talk about the swap in Forex trading, which is a very important part of this market, and many people don’t pay enough attention to it.
We will discuss this very important part of the trading process, which can really make a change while investing in FX. So, imagine a situation that you are trading Forex and want to increase trading positions, but, you don’t have sufficient funds to afford it. Investors in this type of situation would use margin accounts and leveraged funds.
When they are doing it, investors are borrowing a certain amount of money from brokers. Basically, this is some type of loan given by the broker to investors, after doing this, traders are required to pay or be able to receive certain types of interest rates.
We know that it might sound a little confusing, but it really is not. It is a very simple thing that can be understood by everyone very easily. So, follow us as we go into the very details of Swaps and learn how, when, and why you might have to them.
What is a swap in Forex trading?
A foreign currency swap is a currency exchange arrangement between two foreign parties in which principal and interest payments on a loan made in one currency are exchanged for a loan in another currency of equivalent value. There are two major types of swaps in the Forex world, one known as the fixed-for-fixed currency swap, and the other as the fixed-for-floating swap.
The first involves swapping fixed interest payments in one currency for fixed interest payments in another currency, while the other involves swapping fixed interest payments in one currency for floating interest payments in another currency. The principal balance of the underlying debt is not substituted in the second form of a swap.
Once FX traders are starting to use margin accounts, they have some type of an agreement with the broker that they are using. As a result of this agreement, the test can borrow funds from the broker when trading, and return it afterward. But, swaps do come with some requirements which every investor should know about.
When talking about swap charges in Forex, something that every investor on the market should remember is that swaps do not happen when investors are using short term trading strategies. Swaps only happen when the positions are staying open overnight. So, let’s say that you are using one o the short-term trading strategies like scalping or day trading, this means that you will not have to worry about swaps at all.
On the other hand, if you are using a long term trading strategy or swinging trading strategy, you will have to keep swaps in mind as you will be keeping your positions open overnight. When you are opening your positions in the morning and closing them before the end of the trading day, there will be no additional interest rates charged or added to your trading account. But once you decide to leave the position open for more than a day, swaps become something that you might have to pay.
Different types of swaps in Forex
Before we go any deeper into the meaning behind swaps in the Forex trading market, we need to talk about different types of FX trading swaps. The thing about swaps is that according to the trading style you are using, swaps can be differentiated into two different groups. They are:
- Long Swap
- Short Swap
Now, what are the differences between long swaps and short swaps? This is quite simple. If you are a Forex trader and you want to buy a certain currency pair and leave the position open overnight, you will be dealing with a long swap. However, if you are a Forex trader who wants to sell a certain currency pair for more than a day, it will be considered to be a short swap.
When it comes to Forex swap rates, it generally depends on the central bank. Because of the fact that every single central bank around the world has its own policies, the number of interest rates is different from one another. This difference is very important while talking about FX trading swaps, they are what decides if the money is credited on the account of the trader or charged. The amount of money credit or charged from your account will also depend on the commissions of the broker, actual movements of the prices on the market, and the swap indicators of the FX broker that you are using.
How to benefit from swaps
Although there are a lot of people on the market who are very afraid of swaps, if they are used well, they can actually be profitable for investors. As we have already said, there are two ways the swaps can behave, either investor will have to pay them, or it might even get credit on their account. The swaps that give investors credit are called positive swap in Forex.
But how does this really happen? As we have already said before, every single central bank has its own interest rates. Sometimes, if you are using certain types of currencies, you might end up using such a pair that actually credits swaps to your account.
Actually, those people who are trying to make money with the help of swaps even have their own name: carry traders. Those who are doing it are focusing on earning money o the net interest of the difference. However, always keep in mind that no matter what are you doing in this market, there always are some risks involved. FX trading market is changing every moment, and you can’t be 100% sure about the moves that you make on the market.
To become a carry trader, you will have to find a currency pair that consists of one high yield currency and another low yield currency. It is also very important that the currency that you choose has a high-interest rate when compared to the currency it is paired with. In fact, many investors are looking for a currency that has a lower interest rate especially to get the maximum payout.
After you have found a currency pair, now it is time for you to wait for the downtrend, the thing is, it is true that money can be made off of the interest difference, but it can only be done if the difference is positive.
We know that it might sound very complicated at first, but in reality, it actually is a very easy process. However, always remember that the market is changing constantly and the research that you do is of utmost importance. Also, before you start using it, we believe it is very important for you to understand how to calculate swap in Forex.
Positive & Negative Swaps
As we have already said, the swaps on the market directly demand on the Central Banks. The bigger the difference between the rates of the currencies in the pair, the bigger is the swap. A positive swap means that the swap is deposited on your trading account, on the other hand, there is also a negative swap, which is when the swap is withdrawn from your trading account. The swaps are also influenced by the brokers you are using, because of the different prices on commissions and fees.
Can you trade Swap Free in Forex market?
This is very much possible and actually very easy to do. When talking about swaps, something that you should keep in mind is that they only occur during night time. Because of this, it very much depends on the trading strategy that you are using. There are many different types of trading strategies available on the market, if we look at Forex trading strategies as a spectrum, we can see that some of them are short-term trading strategies, while other are long-term trading strategies.
Those who are using trading strategies like scalping or day trading, which are considered to be short-term trading strategies, will not have to worry about swaps at all. As we have already said, swaps are only credited or withdrawn during the night, which means that if you are closing positions before the market closes, you have nothing to think about.
While using scalping and day trading strategy that is exactly what you will be doing. Scalpers are opening and closing several trading positions during the day, but none of the positions last more than a few minutes. Scalpers are not trading during the night, which means that there are no swaps for them. The same goes for day traders as well. They are opening one position a day, which is opened in the morning and is closed before the market hour ends, which means that they don’t have to worry about swaps either.
On the other hand, swingers and long-term traders are opening their positions from several days to several months, which means that they will need to think about swaps a lot before they make any decisions regarding it. But, this is not the only way for avoiding swap in Forex.
In the world of Forex trading, there is this account type which is known as a swap-free account. This account was created for those who follow the beliefs of Islam, and because of this, it is also known as the Islamic Trading Account. This type of accounts offered by most of the Forex brokers in the market.
It was created because according to Quran, Sharia law indicates that it is not allowed for those who follow the Islamic faith to pay or receive any interest. This is exactly what swaps are, and because of this, Forex brokers around the world have decided to come up with swap accounts that give investors of all backgrounds the ability to invest in this market without having to turn back to their beliefs.
Final thoughts on swaps in Forex trading
The thing about Swaps is that while it can be very scary for many people, it can be something very much enjoyed by others. Much like anything else on the Forex trading market, swaps have two sides. It can be very rewarding if investors are able to find ways to make it work, but at the same time, it can be very dangerous.
The thing is, it very much depends on the type of trader you are. If you are very afraid of swaps and simply are not ready enough to deal with this, the market offers you the ability to use trading strategies that will be a guarantee for you that you will not have anything to do with swaps. However, if you see a huge potential in the swaps, you can make them work well for you.
At the end of the day, much like anything else on the market, swaps also depend on the needs and wants of Forex traders, and while it can be very useful for some, it can also be very scary for others.