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What is swap on forex?

Foreign exchange, also known as forex, is the largest financial market in the world. It involves the buying and selling of currencies from different countries. Forex trading is done in pairs, where one currency is exchanged for another. The value of a currency is determined by various economic factors such as interest rates, inflation, and political stability.

One of the key features of forex trading is the use of swaps. A swap is a financial derivative contract that allows two parties to exchange cash flows or assets. In the context of forex trading, swaps are used to offset the interest rate differential between two currencies. The interest rate differential is the difference between the interest rates of the two currencies being traded.

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For example, let’s say a trader wants to buy USD/JPY (US dollar/Japanese yen) currency pair. The interest rate in the US is 2% while the interest rate in Japan is 0.1%. This means that the trader will earn interest on the US dollars they buy, but they will have to pay interest on the Japanese yen they borrow. The difference between the interest rates is called the interest rate differential. In this case, it is 1.9%.

Swaps are used to offset this interest rate differential. The trader can either earn or pay interest on the currency pair they are trading, depending on whether they are buying or selling. If the trader is buying the currency pair, they will earn interest on the currency they are buying and pay interest on the currency they are selling. If the trader is selling the currency pair, they will pay interest on the currency they are buying and earn interest on the currency they are selling.

Swaps in forex trading are usually calculated on a daily basis and are credited or debited to the trader’s account at the end of each trading day. The amount of the swap depends on the interest rate differential, the size of the position, and the length of time the position is held.

There are two types of swaps in forex trading: the rollover swap and the swap-free account. The rollover swap is the most common type of swap and is used by most forex brokers. It is also known as the overnight swap or the tom/next swap. The rollover swap is calculated based on the interest rate differential between the two currencies being traded and is charged or credited to the trader’s account at the end of each trading day.

The swap-free account, also known as the Islamic account, is designed for traders who follow Islamic finance principles. In Islamic finance, charging or paying interest is prohibited. The swap-free account allows traders to hold positions for an extended period without incurring interest charges. Instead, a fixed fee is charged on the account to cover the administrative costs of the broker.

In conclusion, swaps are an important feature of forex trading. They allow traders to offset the interest rate differential between two currencies and earn or pay interest on the positions they hold. Swaps are calculated on a daily basis and are credited or debited to the trader’s account at the end of each trading day. Traders can choose between the rollover swap and the swap-free account, depending on their trading style and preferences. It is important for traders to understand how swaps work and how they can affect their trading performance.

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