What is Swapped During Forex Swap?

Swap is a forex trading term and it means a real-time purchase and sale of the same amount of a selected currency for two different dates for the sale and purchase of another selected currency.

 Forex swap is in a way a borrowing mechanism. You basically borrow one currency while lending another for a selected period of time. In other words swap is interest rates for the currency pairs you sell or buy. Depending on the pair, you may either earn or pay swap interests. 

Highlights

  • A swap in forex trading, also known as forex swap, refers to the interest earned or paid for a position kept open overnight.
  • The rollover interest rate should not be confused with rollovers. The rollover refers to the process extending the settlement date of an open trade. Rollover interest rate relates to the interest rate differential between the two currencies involved in the trade (also known as the swap rate).
  • If the currency bought has a higher interest rate than the one sold, a swap will be credited to the account. If the interest rate is lower for the bought currency a swap will be charged to the account.

Forex swap means that you can buy/sell a base currency today and sell/buy that currency sometime in the future. For example, let’s say you bought fixed amount of Euro for Dollars and sold those Euro 3 months afterwards for Dollars. This is defined as Euro Swap. 

So, how can Forex Swap help you profit? Consider an example: 

Let’s swap US Dollar and Euro. Forex trader enters a swap and buys $100,000 with exchange rate of $0.1 per euro (yeah right! It’s just an example!). At the same time, another trader agrees to sell in 3 month the same $100,000 dollars to buy Euros at the exchange rate of $0.09. During this trade the trader makes up to 50,000 euro profit because the value of dollar changed. 

In other words, forex swap is when the trader and the broker trade one currency for another at an agreed rate and then convert those selected currencies back at a selected date in the future, at the previously agreed exchange rate. The common forex swap involves the combination of a spot transaction and a forward transaction. 

We have already learned that nothing comes cheap and of course there is a cost for forex swap. It is set by the interest rate difference of two selected currencies. The interest rate which you can earn during the swap period is used by the broker to calculate the price of the swap. 

The actual calculation of swap cost involves the rate and the adjustment of the interest rate difference between the selected currencies for the amount of swap period. This gives the forex broker both borrowing and lending rates. This doesn’t end here. The next step is to the swap points which are either added or subtracted from the price. 

Currency swap deals with the exchange of interest in one currency for the same interest in another currency. It is referred to as a foreign exchange transaction. 

Interest rate swap is an agreement where one stream of interest payments is exchanged for another. In other words, it is the exchange of one set of cash for another based on the interest rate conditions. Interest rate swap is used to manage the exposure to instability in interest rates or to get lower margin interest rates. 

What happens if you aren’t interested in swap? Most forex brokers provide both swap and swap-free accounts. The Swap-free accounts are designed for forex traders that do not wish to use this option or can not use swap feature due to their religious beliefs. Many forex brokers refer to swap-free accounts as “Islamic accounts”.    

Using a swap-free forex account allows you roll over the position over night without either gaining or losing any amount. Holding the trading deal for a longer time also assures the trader that only the exchange rate for the set period of time will affect the result of the deal. 

How does swap look like? The trading positions which a forex trader leaves open after a certain hour specified by a broker (usually it is after 11:59:59 PM Hamburg time) is subject to a swap debit or credit. Below is an example table of how the swap rates might look like.

Currency PairLongShort
EURUSD-0.53 pips-1.52 pips
EURCHF-0.41 pips-1.65 pips
EURCAD-0.68 pips-1.38 pips
EURGBP-1.30 pips-0.76 pips
AUDUSD+0.33 pips-2.39 pips
GBPUSD-0.26 pips-1.79 pips
GBPJPY+0.30 pips-2.35 pips
GBPCHF-0.14 pips-1.91 pips
USDJPY-0.47 pips-1.59 pips
USDCHF-0.91 pips-1.15 pips
USDCAD-1.17 pips-0.88 pips

Don’t forget about the weekends. If you roll over the position from Wednesday to Thursday, then the next value date is Monday, meaning the rollover fee indicated as an example in the above table has to be multiplied by 3. Also, it is important to realize that swap rates aren’t fixed and updated daily.

The swap fee varies depending on: 

  • The online broker 
  • The type of position: purchase or sale 
  • The instrument 
  • The number of days the position is open 
  • The nominal value of the position 

Summary

  • A foreign exchange swap refers to an agreement to simultaneously borrow one currency and lend another currency at an initial date, then exchanging the amounts at maturity.
  • Leg 1 is the transaction at the prevailing spot rate. Leg 2 is the transaction at the predetermined forward rate.
  • Short-dated foreign exchange swaps include overnight, tom-next, spot-next and spot-week
  • Foreign exchange swaps and cross currency swaps differ in interest payments.
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