Choosing a broker for trading the forex markets is a very difficult task as one should look at issues like; funds safety, regulations, trading platforms, etc. One very important aspect few traders take into consideration is the type of a trading account the broker is offering.
Trading accounts may vary and brokers are offering different types depending on the funds that are being transferred, the technology being used (ECN –Electronic Communications Network or STP – Straight Through Protocol) and other aspects.
Few traders take into account the swap element when opening a trading account and this may prove to be a fatal mistake.
But what is the swap? This is the difference between different interest rates in a currency pair, and it can be positive or negative. Let’s take the EURUSD pair for example. The swap is being calculated as the difference between the overnight interest rate in the Eurozone and the corresponding one in the United States. In this case, it is a negative one as ECB (European Central Bank) is having a negative interest rate policy for quite some time now.
This means that at the end of each trading day, an amount will be deducted from the balance of your trading account, depending on the positions that are opened at that very moment. Basically, when the daily rollover is coming, if you carry open positions through the next day, a negative or positive swap applies to your trading account.
If the swap is positive, a corresponding amount will be added to your account balance, and if the swap is a negative one, it will be deducted.
The image above shows where exactly those costs/incomes are going to be shown in a statement.
This is very important and depends on the trading style one has. If trading is being made having a medium to long term horizon in mind, like swing trading, then it is crucial to know exactly what kind of a swap each and every currency pair is paying and how to pay as little as possible.
As a rule of thumb, after the 2008 financial crisis, when major central banks started to drastically cut the interest rates, the vast majority of currency pairs are having a negative swap. Only a few are paying a positive one and traders are looking to own those pairs in their portfolio. However, the risk is very high as one may hunt the positive swap and in the same time position on the wrong side of the market.
Islamic brokers are not allowed to offer trading accounts with swaps but one should not be fooled by this as those costs are usually transferred to commissions or they are being the cause of higher spreads on the main currency pairs.
However, there are brokers that offer swap free accounts and this represents a good incentive for picking the right broker. Sometimes there are specific conditions to be met in order to qualify for a swap free account, but these conditions are not that drastic.
A swap free account allows one to fully take advantage of all the opportunities offered by the forex market, as it is known that the market is not moving all the time. In fact, markets spend most of the time in consolidation and being stuck into a position until the consolidation breaks can be very costly if one is paying a negative swap.
Hedging the swaps is also something to consider and it can be done in the following manner. If the swap for being long EURUSD is negative, but being long AUDUSD is positive, then the trading size should be bigger on the AUDUSD pair then on the EURUSD in such a way that the swap costs are covered.
The aim is not to lose money from your trading account, so ending up at break-even when it comes to swap costs is excellent.
The easiest thing to do is simply scalp your way in intraday trading. As long as there is no open position at the end of a trading day, then no swap is being applied to that trading account.
Scalping has a lot of advantages and the one mentioned above is a minor one. However, not all trading strategies are suitable for scalping. For example, if one is trading a contracting triangle on the daily chart using the Elliott Waves Theory, then the market may take some time until the triangle breaks.
That time equals money as swaps are eating from the balance of your trading account.
All the reasons above are important to keep in mind since not all fees and costs are easily visible.