Swap in Forex Market
In comparison with the more simple order types described above, this type of order requires an individual chapter to explain because it is more complicated.
Swap (sometimes also called a rollover or overnight) is the aggregate of two opposite transactions (two buying and selling operations of one currency for the other) of equal sum but with different value dates. The day of execution of the first deal is called a value date and the day of execution of the second and reverse one (detached in time) is called a swap end date. Exchange rates and the cost of the swap operation are set at the moment the deal is made.
Usually the purpose of a swap operation is to extend a previously opened position in order to increase profit or reduce losses.
When the most recent deal is the ‘buy’ one and the detached one is the ‘sell’ one then such a swap is called a “buy and sell swap”. When the selling operation precedes the buying one such a swap is called a “sell and buy swap”.
Typically, a swap operation is held with one contractor (for example with a bank) and is called a pure swap. But in the case of a trader dealing with a broker the inner mechanism of a swap is out of his ttention and is called an engineered swap. In day-to-day life a swap-like operation is when you buy (first operation) some foreign currency, in order to realize a profit by selling it for another currency (reverse operation) some time later (for example a year) when the rate changes (if there is any change). The difference between such an operation and a real swap is that the price of a deal is not fixed for the day-to-day one.
However, the Forex market uses margin and this can lead to complications. For example, if you want to open a position for 500000 EUR/USD at 1.2347 with Spot closing terms (closing in two days) but on the day of the actual transaction you can’t fulfill because you don’t have 500000 euros in capital, but only the margin of 10000 US dollars for example, then you could use a swap operation. You could do it on Tom and Spot terms in two opposite operations. First, you would sell 500000 EUR/USD (for example at 1.2400) under the Tom terms, which means the transaction would take place on the following day and buy under the Spot terms (at the same rate of 1.2400 for convenient calculation) with the transaction occurring one day after the first deal.
The diagram above illustrates what is meant (the dates are relative).
Initially you bought euros with the transaction expected to to happen in two days (from the 17th to the 19th of August) and at the same time you were selling euros on the 18th of August with the value date on the next day. As a result of a swap operation the buying and selling occur on the same day and mutually cancel each other out. You would simply absorb the interest from the shift of the exchange rate expressed
in US dollars.
In other words first you had bought 500000 euro at the 1.2347 by paying 617,350 US dollars and then sold 500000 euros at the rate of 1.2400 receiving 620000 US dollars (and 2650 US dollars in profit). All the complications above appear because you don’t have actual money in your account when trading with marginal leverage. That’s why it is necessary to close and open similar positions in order to mutually cancel out those sums by the value date appointed.
There’s one more important thing that usually escapes newbie traders’ attention: simultaneous Tom and Spot operations are usually held at different prices.
If you try to prolong a buying position in a stronger currency – for example by selling the euro on Tom conditions and at the same time buying it in a Spot operation – it is likely that the purchase operation will be cheaper. At the same time the opposite (selling) position will yield a loss in the case of a stronger currency, but it could yield a gain if the exchange rate falls.
This difference appears because a dealer has to disperse the same currency, while the position is open in the currency which he has to keep in an open position for you as the trader. You are not able to take credit in currency until you prove to him that the position is closed. It is natural that credit interest rates for different currencies are different. By means of the combination described above the trader derives his profit from that delay and credit circumstances as it is more profitable to distribute
Euro (growing and more ask-for currency) and to attract US dollars that in this case do not have strong positions. In case of currencies, periods and exchange rates described above the swap operation profit would be about 9 US dollars or 1/5 part of EUR/USD currency pair point. Due to some legal and bookkeeping
reasons a dealer can’t just pay you that profit (in the form of those 9 bucks). Such profit is usually inserted into quotations and you can gain it by the difference in exchange rates at the moment of a swap operation.
