Understanding Swaps And Spreads In Forex Trading
Forex trading offers you a sustainable way of deploying your risk capital, by allowing you to leverage your initial investment capital many times over. It is common for forex brokers to offer their clients the opportunity to enter into trades that have a value of up to 50 times of the margin required.
Of course, high leverage has a flip side and could be a double-edge sword. Instead of making a large profit, you may make an equally big loss. That is why it is important to use only your risk capital – the amount that you can afford to lose.
Selecting a good broker is also essential. You must make an effort to understand the costs that you are paying. High trading costs can eat into your profits or result in increasing your losses. One area that you must ensure that you familiarise yourself with is that of swaps and spreads.
What do these terms mean and how can they impact your trading profitability?
Foreign exchange transactions have value dates which is a future date used to determine the value of the trade. Shifting the value date of a foreign currency transaction to a date further in the future is referred to as a swap. When you enter into a swap, you are “swapping” one date for another. This could entail a cost.
The cost is referred to as a swap charge. It is determined based on the interest rates of the countries in each currency pair. Remember that you would pay interest on the currency that you have sold and receive interest on the currency that you have bought.
In other words, you would receive interest if the net sum of interest on your currency pair is positive and pay interest if the net sum of interest on your currency pair is negative.
An example of swap points/charges for an open forex position
The following explanation will allow you to understand how swap charges work:
- If you are holding a long position and your buying price is lowered, you are gaining swap interest.
- If you are holding a long position, and your buying price is raised, you are paying swap interest.
Similarly, if you are holding a short position and:
- Selling price is lowered, you are paying swap interest.
- Selling price is raised, you are gaining swap interest.
Say, a trader has an existing long position of EURUSD at 1.1600 and the swap points is -0.0001. This means that your buying price will be reduced by 0.0001. Instead of 1.1600, you will pay 1.1599. You have made a swap interest gain of 0.0001 point.
There could also be a situation where a trader has an existing short position of EURUSD at 1.1600 and the swap is at -0.0001. In this instance, the selling price is lowered from 1.1600 to 1.1599 as swap interest of 0.0001 would be paid.
What are spreads?
The spread is the difference between the ask price and the bid price of a currency pair. To put it another way, it is the difference between the price at which a currency pair can be bought and the price at which it can be sold.
Let’s quickly review what “ask price” and “bid price” mean:
Ask price – the price at which the currency pair will be sold to you. This is the price at which you would buy.
Bid price – the price at which the currency pair will be bought from you. This is the price at which you would sell.
There will always be a difference between these two prices. Say, if the bid and ask prices of EURUSD are 1.1600 and 1.1602, the difference, which in this case is 2, is known as the spread. A lower spread is beneficial to the trader. A higher spread indicates that there is a higher cost to you when entering a trade which would impact your profit and loss.
Phillip Futures offers among the lowest bid and ask spreads in the market. The following figures will illustrate this point:
Phillip Futures’ MT5 platform VS Competitors’ platforms
|Bid and ask spread on:|
Dealing with a broker who offers the lowest spreads can help you to maximise your gains from forex trading.
Phillip Futures offers its clients the advantage of the lowest spreads as well as the most attractive swap charges:
|Currency Pair||Phillip Futures*|
*Spreads and Swaps taken from Phillip Futures’ MT5 platform
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This article is kindly contributed by Phillip Futures.
Phillip Futures is one of the region’s top brokerages for the trading of global futures, foreign exchange, energy, metals and commodity futures. It was established in 1983 as a member of PhillipCapital Group, and was one of the founding clearing members of Singapore Exchange Derivatives Trading. It currently holds the Capital Markets Services Licence issued by the Monetary Authority of Singapore (MAS).
Phillip Futures is also the first to launch the powerful MetaTrader 5 (MT5) platform in Singapore. MT5 offers advanced technical analysis tools and allows traders to create their own trading strategies