In online financial trading, a swap or rollover refers to the overnight interest or financing fee that traders may incur or earn when holding a position overnight. Mostly, a swap will be a fee to be paid, and it can impact trading profitability depending on the differential of interest rates. Swap is the cost or gain associated with the interest rate difference between the two currencies being traded. Traders either pay or receive swaps depending on the direction of their trade and the interest differentials involved. 

Who is subject to swaps or rollovers?

Day traders and swing traders who usually hold trading positions for more than 24 hours pay swaps. Day traders, thereby, always look for lower trading commissions as they depend on the medium-term results of their trades. Scalpers, on the other hand, have their trading positions opened for less than a day and do not care about swaps. 

Islamic accounts come with zero swaps. Since Sharia law prohibits paying or receiving an interest rate, many brokers offer Islamic accounts that have no swaps to Muslim traders. Swap-free accounts typically come with higher spreads to ensure the broker still makes money. 

Swaps have several key functions in FX trading. The primary function is to provide an interest rate compensation. Before we continue speaking about interest rate compensation, let’s explain what EURUSD and other pairs represent in FX. In EURUSD, the EUR is the base currency and the USD is a quoted currency, meaning that the pair shows how much USD you will need to buy 1 EUR.

Swaps compensate traders for the interest rate differential between the two currencies traded. 

If a trader holds a position in a currency pair where the base currency (EUR) has a higher interest rate than the quoted currency (USD), they receive a swap payment. The opposite is true when the trader has to pay a swap.

Swaps also serve the purpose of facilitating overnight positions, enabling traders to hold positions overnight or during weekends. Some traders also use swaps as a risk management tool. Traders can hedge against interest rate fluctuations that may affect their trades. 

Let’s take an example. If a trader expects interest rates to change, they can structure their trading positions to either benefit from or mitigate the impact of these changes. Although some traders use swaps to earn money, it is highly risky and beginners should avoid that activity. 

How Swap Affects Traders

The main influence of swaps on traders comes from increased costs or increased profits, depending on the conditions mentioned above. Swaps can have an impact on trading performance, but it is usually tiny and should not affect the results greatly. It is always recommended to check swap dates and details before entering a long-term trading position. 

Several trading methods exist to make profits using swaps, but they are risky. 

Market Timing

With proper timing, traders can incorporate swaps into their trading decisions based on anticipated interest rate changes. If the trader expects the interest rate to move in a particular direction, they can adjust their positions to benefit from these changes to protect against them.

Long-Term Strategy

Long-term traders can specifically choose currency pairs with favorable swap rates to maximize their returns over time. In this case, swap rates can play a major role in determining the long-term profitability of the trading system. 

Carry Trade Strategy

Carry traders specifically are focused on earning a swap income. This is highly risky and requires significant knowledge of macroeconomics and financial markets, and is not recommended for beginners. Carry traders borrow funds in a currency with a low-interest rate and invest in a currency with a higher interest rate to earn the interest rate differential as a profit. There was a specific term in Japan where this approach was super popular among women who were managing household money. They were called Mrs. Watanabe. In this case, whenever the exchange rate changes quickly losses may exceed profits many times, and this strategy is known to be highly risky. 

There are several factors directly affecting swap rates, and the majority of them are fundamental. 

Central banks have probably the most influence on swap rates, as they are directly tasked with interest rate decisions. Monetary policy announcements and interest rates can radically influence swap rates and traders who use any strategies described above, must monitor interest rates constantly. 

Economic data and indicators such as GDP growth, employment change, and consumer sentiment can also impact swap rates. Market sentiments such as uncertainty or geopolitical events can force traders to seek lower-yielding currencies, affecting swap rates.