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What is the meaning of swap in forex?

Forex, also known as foreign exchange, is the largest financial market in the world. It operates 24 hours a day, five days a week, and sees trillions of dollars traded daily. In this market, traders buy and sell currencies with the aim of making a profit. One of the many terms used in forex trading is swap. In this article, we will explain the meaning of swap in forex trading.

What is a swap?

A swap, in forex trading, is the interest rate differential between the two currencies in a currency pair that a trader holds overnight. When a trader holds a position overnight, they are subject to an interest rate differential between the two currencies. This interest rate differential is either a positive or negative value, depending on the currency pair.

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A swap is calculated based on the interest rates of the two currencies in a pair, and it is usually expressed in pips. In simple terms, a swap is the cost or earnings that a trader incurs for holding a position overnight.

Types of swap

There are two types of swap in forex trading: positive swap and negative swap.

Positive swap: A positive swap, also known as a rollover credit or rollover interest, occurs when a trader earns interest on the currency they have bought. For example, if a trader buys EUR/USD and the interest rate for EUR is higher than USD, the trader earns a positive swap. The amount earned depends on the size of the position and the interest rate differential.

Negative swap: A negative swap, also known as a rollover debit or rollover cost, occurs when a trader pays interest on the currency they have sold. For example, if a trader sells GBP/USD and the interest rate for GBP is lower than USD, the trader pays a negative swap. The amount paid depends on the size of the position and the interest rate differential.

Why does swap exist?

Swap exists because of the difference in interest rates between the two currencies in a currency pair. Central banks around the world set interest rates to control inflation and stimulate economic growth. When a trader holds a position overnight, they are essentially borrowing one currency to buy another. The interest rate differential between the two currencies reflects the cost or earnings of holding that position overnight.

How is swap calculated?

The swap rate is calculated based on the interest rate differential between the two currencies in a pair, the size of the position, and the number of days the position is held.

The formula for calculating the swap rate is as follows:

Swap rate = (Interest rate differential / 100) x Position size x Number of days

For example, let’s say a trader buys 1 lot of EUR/USD, which has an interest rate differential of -0.75%, and holds the position for 3 days. The position size is 100,000 EUR.

Swap rate = (-0.75 / 100) x 100,000 x 3 = -2,250 USD

This means that the trader will pay a negative swap of 2,250 USD for holding the position overnight.

Conclusion

In conclusion, swap is an important concept in forex trading, and it reflects the interest rate differential between the two currencies in a currency pair. A positive swap means a trader earns interest on the currency they have bought, while a negative swap means a trader pays interest on the currency they have sold. It is important for traders to consider swap when holding positions overnight, as it can affect their overall profitability.

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