How to EARN interest with SWAP when trading Forex
Forex Traders have swap rates or interest on their currency positions.
Now, this can be a bit of surprise actually for new currency investors who weren’t aware of this actually happens, but it’s pretty easy to explain and it’s easier to look at how it is really playing out of my portfolio.
And there are even strategies that are based on the fact that swap or interest is being paid or charged on your Forex positions.
So, the best way to explain this is to look at a specific example and talk about why there’s interest being charged outside the position and be paid on the other side the position.
Let’s take a look at the AUD/USD. Now, this is a good example right now because it’s very dramatic actually.
The AUD/USD when you buy the AUD/USD exchange rate, in essence what you’re doing is your long in AUD and your short in USD, so, because what you’re hoping to do and in a way, you could look at this. I sold some US dollars, so, it’s like I’m borrow those to buy and hold the more valuable or the asset that I expect will become more valuable, I’m long AUD/USD, I’m long the base currency.
Now, if we borrow money, we’re going to have to pay some interest on that. Right? and if we own money, we’re probably going to get paid interest. Won’t we?
What happens is that their interest rates are not equivalent from one economy to the next.
Here we have an example, we have the AUD around 4%, That’s their Benchmark interest rate. That’s the interest rate set by their Central Bank.
We have the similar situation here on the U.S. Dollar with 1% interest.
So, if you were to look at this as representative of the interest that you would be charged for borrowing dollars and then should be paid for owning and depositing AUD, then you got a differential here.
Here what happens, if your long AUD/USD exchange rate, then you get paid a small premium, so you get paid SWAP.
Now, in this case, if you’re long you’ll be paid.
I think right now the swap rate is just under one pip, which means a pip per lot. So, you own a full-size lot, that means you’re being paid $9.50 a day in swap.
So, let’s take a look at this. So, $9.50 a day, that’s almost a full pip, that you’re being paid every day for to hold one long position in swap.
Now, what about if you are short?
Then things changed just a little bit, but they look very similar. So, if you’re short to this particular currency pair, then everything shifted here a little bit, because now, you’re anticipating that the dollar is going to strengthen, then everything shifted here a little bit, because now you’re anticipating that the dollar is going to strengthen, it’s going to start to drop.
I see if you’re shorting up their currency pair which means that you’re now borrowing AUD, holding the dollar. Now this differential at that point is working against you so.
Now, no long where are you making a swap rate, you’re paying a swap rate.
You’re probably being charged somewhere let’s say a $10.50 a day or just over one pip a day to hold a full-size lot.
If you are holding 3 lots, it’ll be 3 times this, if you are holding half, it’ll half of this.
So, you can see the idea how this actually plays out. Now Swap it’s pretty easy understand and you can see on your total position.
So, when you’re looking at the Metatrader 4 platform and you can see there’s a column in the terminal under the trade tab for swaps and see how much I made into your overall profits.
But beyond that actually, because there are a lot of strategies that are built around the fact the swap even exists.
One of these strategies talked about all the time so even if you don’t want to trade it it’s something it’s useful to know about.
So, we’ll talk about that next, you probably heard this expression quite a bit as trader, reporters, Analyst, etc are talking about. Traders are into the carry trade or their unwinding the carry trade.
This is typically in the long-term positions. They’re based on this interest differential. There’s a classic example actually for several years since the early 2000s, traders would buy the pound/Yen.
So, they buy that particular currency pair because there was a very high interest rate available in the pound very low interest rate available on yen. So, they would be getting a interest differential for years at a time. That’s critical to know that’s a pretty good strategy. Some institutional player trade all the time.
So, the carry trade very popular, but all strategies you really need have to understand, well, is it working now, when is it working, when should I play it.
You really need to understand your technical, your fundamentals, to know that, well, right now it looks pretty good or right now I don’t want to play it. I’m going to look for other currencies that are offering different kinds of opportunities of a lot more confident about offering different kinds of opportunities a lot more confident about.
Another version of this by the way is that traders will accumulate a carry trade portfolio. So, they may the long several high interest-bearing currencies like the AUD, NZD, and even some more unusual crosses, like they recently the krona has been one of those categories, and they’ll be short at the YEN or CHF.
Some of these low-yielding currencies at other side and what they’re trying to do is to diversify out their portfolio, not to get so leverage but diversifying out their portfolio, not get to leverage but diversify this out.
So, they’re taking advantage of several different currencies pairs and not just concentrating on the EUR/YEN or GBP/YEN as many traders did the last past years.
So, this is something to keep in mind as this is an essential strategy. So, if the markets are operating fairly normally, especially if it’s a more bullish or growth environment the carry trade performs really well and it’s one way to apply this concept of swap interest in the Forex, conversely, when Global growth is really constrained, recession and things like this, then the risk environment changes in the carry trade, which is in and another cell fairly risky position, becomes much less desirable and does perform very well at all.
So, learn how to apply this signals in the proper Market environment.
This is a great example of how to apply one concept that exists in the Forex to a trading strategy.
Now, we always give this tip when we talk about complicated subjects like interest or Swap. Take a minute, review the video, review what we have showed, and If you feel comfortable with it, go and explained to explain it to someone else.
There is no way to learn better than trying to teach somebody else. So grab a captive audience, a family member, or a good friend will put stop with you, and explain to them how this works.
Let them ask you questions and you can explain to somebody else, you really understand if you’re ready to apply it in your own trading portfolio.
It was one last thing we would like to mention about this interesting thing of Swap in the Forex, because it is kind of a unique thing or it gets even a little bit more unique about midweek on Wednesday.
So, in the Forex, you’ll notice it, if you’re holding a position over Wednesday your swap charge or credit swap charge, or credits that debit or credit to your account, depending on which side of a transaction you’re on triples on Wednesday.
That’s because the markets are essentially closed on Saturday and Sunday. So, those 2 days are wrapped up into Wednesday, but if there’s nothing to be concerned about.
It just means that if you’re on the right side of that transaction, so you’re getting paid Swap, then Wednesday’s will be a pretty good t day.
If you’re on the other side, then your paying Swap if it’s being taken it out of your account, then Wednesday is a little bit wrap.
So, you are better hold the transactions going the way that you forecast that it would.
So, it’s one more thing to keep in mind, so, you don’t get caught by surprise in those window Wednesdays when the charge credit looks a lot bigger than it would otherwise.
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