Swap is an interest fee that is either paid or charged to you at the end of each trading day. When trading on margin, you receive interest on your long positions, while paying interest on short positions. The net interest difference is known as the carry and traders seeking to profit from this are known as carrying traders.
Positive carry results when you receive more in interest than you are required to pay, and is added directly to your account. If the carry is negative, it is subtracted from your account. If you open and close a trade within the same day, the trade has no interest implications.
If you’re interested in placing a carry trade, the first step is finding a high-yielding and low-yielding Forex currency pair. Some examples of low-yielding (or funding currencies) are the Japanese Yen (JPY), the Swiss Franc (CHF), and the Euro (EUR). As far as high-yielding currencies go, the Dollar (AUD) and New Zealand Dollar (NZD) are popular, though more advanced carry traders might look to the South African Rand (ZAR) or other exotic currencies.
Let’s use the Euro and Dollar: rates in the Eurozone are currently below 0, whilst interest rates are relatively higher, currently 2%. This means that there is an opportunity to earn carry buying AUD with EUR ie going short EURAUD. Great, simple right?
Sadly it’s not that easy – there is no point earning a pip a day in a swap if the pair is moving against you 100 pips/week. That is, if we wanted to perform a carry trade on EURAUD, we would wait until the pair was trending down, sell into any strength, and hold for the length of the downtrend.
Think of swap as a bonus or incentive for holding a trade long term (or in the case of a negative swap, a deterrent).
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