What is currency swap?

Currency swap is the interest rate that is paid or received at the end of each trading day. When you trade on margin, you get paid for your long positions, while you have to pay for your short positions. If the money to be paid is more than the money to be received, traders can profit from such an opportunity. Such traders who earn profit from receiving swaps are called carry traders.

The size of the swap is based on the difference in interest rates in the currencies of a currency pair. Due to the fact that the interest rates of currencies of different countries are different from each other, the swap rate can be negative or positive. It is important that the policies of central banks change over time. This means that interest rates and swap rates can also change.

Therefore, if the interest rate of the base currency is higher than that of the secondary currency, the swap amount will be positive. On the other hand, if the interest rate of the secondary currency is higher, the swap rate will be negative. In the following, we will explain how to calculate the swap rate of a currency pair with an example.

Let's say you bought the EUR/USD currency pair. If the interest rate is 2% for the Euro and 1% for the US Dollar, the overall swap rate to carry this position to the next day is 1%.

On the other hand, if we sell the EUR/USD currency pair, it means that we have bought the US dollar and sold the Euro. In this situation, the overall swap rate for transferring this position to the next day will be -1%.

If we sell the US dollar, it is the same as borrowing it and basically we have to pay 1% interest rate on it. When we want to sell something we don't own, we have to pay interest on borrowing it. Instead, when we sell the euro, we get an interest rate on it.

So, when we buy something we get interest rate and when we sell something we have to pay interest rate. And finally, the difference between these two interest rates represents the overall swap rate of our transaction.

Most of the time, inexperienced traders believe that if they pay for swaps to hold their positions, they are at a loss. But this is an inevitable issue that you should always consider the swap costs when trading currency pairs in the forex market and think of it as part of your trading costs.

Due to the fact that the interest rate of the currency of developed countries is very low, the amount of swap paid or received will not be significant. However, holding such positions for too long can take a toll on you. Therefore, if you plan to keep your positions for a long time (several months or years), it is better to go for swap-free or Islamic trading accounts.

If you don't want to pay swap rate for your trades, you should look for swap-free or Islamic trading accounts. The reason for choosing the name "Islamic" for such accounts is that the Qur'an forbids Muslims from carrying out transactions in which interest rates are charged. For this reason, paying or receiving swap can also be against the laws of Islam. But to create a way for Muslims to participate in the foreign exchange market, swap-free accounts are offered by some forex brokers.

It is worth noting that not all forex brokers offer swap-free accounts. Of course, in this case, traders will still pay for the transfer of their trades to the next day, but in a different way. Therefore, before opening a swap-free account, read its rules carefully, because the commission received in this type of trading account is higher.

Aron Groups Broker is a forex broker that allows its clients to create Swap-free accounts (Islamic accounts). Traders who don’t want to pay swap, according to their beliefs or any other financial reasons, could use this type of account to their advantage.

As mentioned above, some traders trade in the forex market with the intention of profiting from swap. This trading strategy is known as carry trading strategy.

The carry strategy will perform better in currency pairs which the difference in the interest rates of the currencies is greater. Some of these currency pairs include British Pound to Japanese Yen (GBP/JPY), Australian Dollar to Japanese Yen (AUD/JPY) or New Zealand Dollar to Japanese Yen (NZD/JPY). The basic idea of ​​this strategy is to buy a currency with a high interest rate, and sell a currency with a low interest rate. In this case, you can benefit from price changes and you can also benefit from the difference between the interest rates of these two currencies. To profit from this strategy, one must take a long-term view, keeping each position open for at least a few weeks, months, or even years.

When you trade using a carry trading strategy, you don't need to pay attention to price movements in daily intervals. Don't be afraid to suffer a little loss at first. Considering that the swap rate of your transaction is positive, your profit from this transaction will increase as time passes.

Written by: Mohsen Mohseni (Aron Groups).