In the Forex market, all the positions have to be expired at 10 P.M. GMT every day. Fortunately, that does not mean that you will have to close out all your trades. What will happen, is the broker will roll over the open positions automatically, which means they will be exchanged (swapped) for new positions.
When you hold a position overnight, the liquidity provider has to do the rollover process. But the two currencies are not valued at the same price. The difference in the value of the two currencies resides in the interest rate differential – the difference between the benchmark interest rates in two countries.
The larger the interest rate differential, the larger the impact from rollovers. The narrower the interest rate differential, the smaller the effect from rollovers. You can find information on interest rate levels of the major currencies on most financial-market websites.
For a long position in the AUD/USD, for example, you have a benchmark interest rate of 2.5% for the Australian Dollar and a corresponding 0.250% for the U.S. Dollar. This usually translates into a favorable SWAP for you, because you took a long position into a high-yielding currency while being short the lower yielding one. As a consequence, you will be credited in the form of a positive SWAP. This is basically what a standard SWAP operation consists of.
A favorable SWAP is essentially a guaranteed profit, and this is exactly what some investors try to exploit via carry trades. Unlike most strategies for the Forex market, carry trading does not hinge upon exploiting changes in the value of a currency pair but instead aims at exploiting the interest rate differentials in the currency pairs.
Keep in mind:
- If you are long and the base currency has a higher interest rate than the quote currency, you will profit from the swap effect.
- If you are short and the base currency has a higher interest rate than the quote currency, the swap will result in a loss.
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