The interest rate differential between a pair of currencies can either be your best friend or your worse enemy when trading forex since it affects forex rollover rates.
Forex rollovers affect just about any trader that holds positions overnight, and can have an especially strong impact on a carry trade strategy.
Furthermore, this important interest rate effect gets magnified in currency pairs that have a high interest rate differential between the currencies involved.
The following sections will describe the basics of forex rollovers, including how they work and the importance of swap spreads.
Forex Rollover Basics
Most forex traders that hold positions overnight have come across the rollover. From a personal forex trader’s perspective, this daily event usually occurs automatically at many online forex brokers if a position is held at 5pm New York time.
In general, such overnight positions will be credited pips if the trader is long the high interest rate currency, but charged pips if the trader is short the high interest rate currency.
Traders who hold positions at the rollover time will usually find that their positions will be either charged pips or credited pips automatically as they are rolled from the spot value date to the next business day by their broker.
Forex Rollover Mechanics
The actual mechanics of a rollover involve a forex swap in which the position is closed out for its original spot value date and then reopened at a value date one additional business day in the future.
Furthermore, on Wednesdays, when the value date of their position is usually rolled from Friday to Monday, the rollover charge or credit will then include the extra two days of interest that accrue over the weekend.
This rollover swap will generally be done at different rates on each date. Also, if the rollover occurs at the historical rate of what the spot position is being held by the trader at, then the swap will generally be known as a historical rate rollover.
Forex Rollover Spreads
Some online forex brokers offer better spreads on rollovers than others. This can have a significant impact on your bottom line if you plan on holding forex positions overnight on a regular basis.
Swing traders, trend traders and carry traders all tend to fall into this category of holding positions overnight, since they generally trade over a longer-term time frame than what intraday traders tend to focus on.
Accordingly, personal forex traders would be well advised to check out how their broker handles rollovers and what their swap pricing is like if they might be doing rollovers frequently.
Forex Rollover Example
As an example of a rollover transaction, consider the situation of a forex trader who is running a long position in Australian Dollars against the Japanese Yen for value spot, or two business days from today in the amount of 1 million Australian Dollars with a forex broker that performs automatic rollovers.
Furthermore, they were AUD/JPY long at a rate of 75.00 and the rollover swap at their broker is 10 pips.
At 5pm New York time, the broker could sell this trader’s 1 million Australian Dollars against the Japanese Yen for value spot at their existing rate of 75.00.
They would then simultaneously repurchase 1 million Australian Dollars against the Japanese Yen for the trader for value the following business day at 74.90, a rate 10 pips better to reflect the swap points.
In this rollover process, the trader would pick up 10 pips on their AUD/JPY position and improve the rate on their long position from 75.00 to 74.90 due to the interest rate differential that favors the Australian Dollar over the Japanese Yen.