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Forex basic - Swap

Market swaps are used to roll over open positions overnight in the Forex markets. They can be either positive or negative depending on the difference between interest rates. The sum, credited/debited as pay for rolling over a position is called Storage. The final swap amount is dependent on many factors, such as current interest rates in different countries, movement of the pair under scrutiny, forward market conditions, dealers expectations and swap-points of the broker's counteragent. We provide a theoretical basis for market swap calculations below.

Suppose that the interest rate of the European Central Bank (ECB) is 4.25%, and the FED interest rate is 3.5% per annum. Let's assume that you have a short position (Sell) on EURUSD per 1.0 lot. Respectively, you sell 100,000 EUR. In other words, you borrow them at a rate of 4.25%. By selling the Euro, you buy US Dollars, which are deposited at a rate of 3.5%. If the interest rate of the country whose currency you bought (USD – 3.5%) is more than the interest rate of the country whose currency you sold (EUR – 4.25%), the swap will be credited to the trading account in the deposit currency, otherwise it will be debited. It is also worth mentioning that swap also includes the broker's commission for rollover.

In total, your cost for this transaction is 1% per annum (the difference between the interest rates "InterestRateDifferential" = 4.25% - 3.5% = 0.75%), plus the broker's commission for transferring your position to the next day (0.25%). It is then necessary to convert the swap value, expressed per annum, into the deposit currency.

Example 1. Rollover of Short positions (Sell) in the Forex market:

If you buy a currency with a lower interest rate (USD – 3.5%) than the one you sell (EUR – 4.25%), the swap will be debited from the trading account.

Let's consider the formula:

SWAP = (Contract * (InterestRateDifferential + Markup) / 100) * Рrice / DaysPerYear, where

Contract = 100,000 EUR (1 lot)

Рrice = 1.3500 – current market price of the currency pair (EURUSD)

InterestRateDifferential = 0.75% – the difference between the countries' interest rates

Markup = 0.25% – broker's commission

DaysPerYear = 365 – number of days in a year

Calculation:

1. SWAP = (100 000 * (0.75 + 0.25) / 100) * 1.3500 / 365 = 3.70 USD

This means that when the open short position on EURUSD is transferred to the next day, 3.70 USD will be debited from your trading account for each lot.

Forex basic - Margin

The deposit given to the broker by the trader is known as a MARGIN. Margins are required in order to use leverage. A broker demands this margin so that the opened position is maintained and sustained. The amount of margin demanded varies from broker to broker. A trader will offer the collateral in order to ensure and guard that his broker is not under threat of any credit risk.

Before calculating the margin requirements to open a position, you must consider the type of the trading account on which the transaction is made.

Margin – This is the amount of money that is currently being used to hold your positions open and is calculated as such: Rate*Volume traded/leverage.

e.g: If you trade 1 standard lot of EURUSD (let’s assume the rate to be 1.4300) and your account has a base currency of USD and you use a leverage of 1:500, then the margin used will be: 1.4300*100,000/500= $286.

Margin=rate per diposit cur*contract size/leverage

Margin Level – This is calculated by the formula of Equity/Margin. If you have a standard account and your Margin level falls at or below 20% then your position will be closed. For Micro accounts this level is at 5%.

Free Margin – This is your current Equity minus your Margin.  It is in effect the money you have   available to open new positions.

Margin – the collateral

Base currency – the first currency in the currency pair, for example:

EURUSD – the base currency is EUR

USDJPY – the base currency is USD

GBPJPY – the base currency is GBP

Contract – the contract size in the base currency. The size of 1 lot is always 100,000 units of the base currency. Respectively, 0.1 lot = 100,000 * 0.1 = 10,000 units of the base currency, and 0.01 lot = 100,000 * 0.01 = 1,000 units of the base currency

Leverage – leverage, for example:

leverage 1:500 – 500

leverage 1:100 – 100

After calculating the margin in the base currency, you must convert it into the deposit currency (at the rate when the position is opened), e.g. USD, EUR.

Margin Calculation on a pamm.mt4 account

Margin calculation on a pamm.mt4 account with USD as the deposit currency:

Trading Instrument (Currency Pair) – EURUSD;

Base Currency – EUR;

Lot = 0.1

Contract = 10,000 EUR (100,000 * 0.1 lot)

Leverage = 1:100 (100)

EURUSD Rate at Position Opening = 1.3540

Deposit Currency – USD

Calculation:

Margin = Contract / Leverage = 10,000 EUR / 100 = 100 EUR

2. We then convert the margin into the deposit currency (USD). If USD is the first currency in the pair under consideration, the margin should be divided by the rate; otherwise multiplied:

Margin= 100 EUR * 1.3540 = 135.40 USD

Margin equals 135.40 USD