Forex margin trading and Swap
The most hard to understand is the swap in the forex margin trading. It is characteristic in the forex margin trading that the carrying position is automatically rolled over using the forex swap. Let us explain what the swap is, which makes you able to carry your position day after day.
In the interbank market, the spot forex makes it a rule to make a process to settle two business days after the trade date, but the forex margin trading has no need to pay or receive the full amount of the contract values. The forex margin trading system allows to set off the profit or loss within the margin account. If the position is closed clearly in a day, the relevant profit or loss is forced to net to the account balance. Needless to say, you can carry your position to the following day. This is called as "rolling over". This process of rolling over is left continued automatically every day until the position is liquidated. There is no time limit for carrying position in the forex margin trading.
The rolling over day by day should be proceeded using swap, which is the combination of buying contract and selling at the same time on the different value dates. The swap is essentially traded for the foreign currency funding. Let us assunme 1 million US dollar versus Japanese Yen which to be bought and sold.
(1) Buying USD and selling JPY on the spot date, which is two business days succeeding to the trade date.
(2) Selling USD and buying JPY on one month correspondent to the spot date
You have to pay JPY and receive USD at the spot date that is two business days after the trade date. Thus, first, your aim to raise fund in USD results in achievement. After one month passes, the value date of (2) comes, you would have to pay the relevant USD and receive JPY. In this way, it follows that you should raise the fund in USD using the collateral in JPY during that period. Stop here a bit. In case that the interest rate of JPY is assumed to be 1% and that of USD to be 6%, it should be a bad trade for the USD lender for that one month, isn't it? Therefore, the swap trade has the market convention that the trading price should be adjusted in advance not to be disadvantage for the side who is placing higher yield foreign currency. This price gap is just called as the swap point arising from the differential of interest rates yielding between two currencies. In case that the commodity currency yields higher interest than the base currency, it follows to be called as discount system. One the other hand, in case that the commodity yields lower, it should be as premium system. It is needless to say that there does not exist any exchange risk because the trade of buying and selling would be made at the same time.
It does not make sense that the swap is traded itself. The banks use the swap trade for covering the foreign currency deficit during the necessary period. In the forex margin trading, the swap trade is made use of for the position rolling over day by day. If you buy US dollar in the forex market, you would need to pay JPY two business day succeeding to the trade date, but you can postpone the payment schedule using the swap trade. When your position becomes sure to leave open at the end of the day, you have to take action to avoid JPY payment on the following day. You have to make a swap trade that forces you buying JPY and selling USD on the original payment date and selling JPY and buying USD freshly with some swap points on the following day of the original payment date. Most forex brokers usually make this swap trade automatically without customers' permission. In addition, this swap trade cost no commission fee. In this way, individual investors can carry their position for ever. As the swap trade is defined as a purchasing agreement and not a loan agreement, the forex margin trading allows investors to raise fund at on-balance without any loan agreement.
Swap trade adjusts the trading price arising from the differential in interest rates. Looking at the trade of long position in USD-JPY as we have mentioned above, and the cost of the position is decreasing day by day. It means a little advantageous for players whi have USD-JPY long position because the price they got originally becomes lower. This is caused by the swap trade for rolling over at the end of the day, and as a result, the trading price is adjusted, which is arising from the interest rate earning between US dollar and Japanese Yen.
To say exactly, the old position is set off by one side of the swap trade and the new one is set up by another side of the swap trade with taking the carrying cost into account. The swap trade itself yields nothing. Roughly saying, the higher yield currency is decreasing its values with passage of time. Even if you get some swap points in favor, the value would be going down in the forex market. Adversely, the interest rate might be going down when the value of higher yield foreign currencies is going up.
Swap point is neutral
Many investors seem to focus on the higher yield foreign currencies to get some swap points. Turn your eyes to the essence what the interest rate exists for. In general, the bluechip companies can borrow money from the bank in lower interest rate, while the others are required higher interest rate to raise fund. Forex market is the same here. The value of lower yield foreign currencies should be going up in natural under the circumstance that any other conditions remain the same. As long as the power is carrying on, someone can swim up against the stream, but will be flashed away when they are exhausted. The gap of interest rates between foreign currencies is correspondent to the speed of the stream. It is often heard that many individual investors could lose much money in the higher yield foreign currency deposit, but please make sure of this fact trying the forex margin trading. On the contrary, the purchasing position of lower yield foreign currency devalues the carrying cost due to rolling over and it feels that some losses would arise. It is only adjusted in advance by the disadvantageous interest rate earning. There is no juicy story on the earth. In the forex margin trading it should make both sides of position equal. Take it into your consideration that you should aim the capital gain by price movement instead of the income gain like the higher yield foreign currencies.