Forex Rollover and Swap


SHAUN: Okay, so we are going to go overrollover and what it is.

It's really just the interest that accrues for holding an openForex position.

So when you place a trade, you guys know that we're tradingon leverage, and when we trade the one lot of the euro-US dollar, we're trading100,000 Euros and then we're selling whatever the equivalent is in USD at thetime.

Right now the rate 1.

30, so that means we are buying and selling 100,000Euros and exchanging that for 130,000 dollars.

This is when euro-USD is equal to1.


Make sense so far? Okay.

Now, unfortunately, everybody wants interestand they want their pound of flesh.

And you're not just paying for the money inyour trading account; you're actually owing interest and earning interest for thepositions that you have open.

To use current examples, interest rates are athistoric lows.

And they use the overnight rate for setting the interest rates on aposition.

The euro overnight lending rate is set at 0.

01%, basically free money.

Andthe US dollar has an overnight lending rate of 0.


These are annual rates.

It'sactually pretty equivalent to what you're getting paid on a CD, almost nothing.

Butthat does have a cost associated with it, and when you look in MetaTrader itreferences it as "The Swap".

But in the industry it's more commonly known as"Rollover".

You have to pay interest for the positions that you do have open,because they have value.

When we decide to buy the euro-US dollar, that means weown Euros, and we sold dollars.

In interest terms that means that we areowed interest, and we owe interest.

QUESTION: [inaudible 00:02:35] SHAUN: Right, so if you're buying a euro,and this is in magical fairy land where you earn and pay the exact same amount forrollover, we'll get into the exceptions in a minute, but in the pure scenario you'reonly earning.

01% annual interest on your euro position.

But you're paying.

15%interest on your dollar position.

So if you're buying the Eurodollar, if you heldyour position for a year you would expect to accrue a loss of 0.

14%, which is.

15% -.


If you did the exact opposite, so if sold the Eurodollar, you're going to onlyowe.

01% overnight interest, but you're going to make.

15% interest.

QUESTION: Are you assuming that youhave a position open the entire year? SHAUN: Yes.

Now, of course, these rateschange.

These are overnight rates, which mean that overnight they are going tochange on a daily basis.

So the amount will fluctuate.

Slowly, but it does fluctuate.

So this is in the hypothetical example where you bought the Eurodollar, theserates never change, and you held the position for precisely one year.

This isbought euro-USD, and sold euro-USD.

You guys following so far? QUESTION: So that's one whole lot rightthere? SHAUN: Yes, this is precisely one lot.

Because one lot is the equivalent of 100,000 base currency units.

Our basecurrency here is the euro.

100,000 of the base currency is 100,000 Euros.


Solet's actually go through and calculate what the rollover would be in our scenarioof buying one standard lot of the Eurodollar.

So here, it's just.

01 of100,000.

So we have this, the interest, is equal to 0.


100,000 x 0.

0001 = 100Euros.

Of course you have to put that back in dollar terms.

So 100 Euros x 1.

3dollars means you have a debit of 130 dollars for holding the position for anentire year.

It's the same calculation with different numbers.

QUESTION: I thought that was what youget.

SHAUN: Oh, yes, I'm sorry.


Because we bought Euros.

So we only have a credit of 130 dollars for theyear.

The problem is that we're going to owe more for the dollar position, becauseit has a higher interest rate and we sold it.

So, again, same calculation but differentnumbers.

And thank you for pointing that out.

So here we have 130,000 dollars x0.

0015, and this is a negative number because we owe it.

Does anyone have acalculator on their phone? 195? What did I do wrong? Is this supposed to be 13?Okay, 13 dollar credit and 195 dollar loss.

In this scenario 182 is the amount ofmoney we are going to lose after one year in our hypothetical scenario of theEurodollar exchange rate not fluctuating, the overnight interest rate not fluctuating,and us holding our position for precisely one year.

Make sense? Okay.

The nextthing is we need to go over the mechanics of rollover and how it's charged.

It's alittle quirky.

I'm stating the obvious here but there are seven days QUESTION: [inaudible 00:08:06] SHAUN: It doesn't matter.

If you have aposition of 100,000 Euros, you owe 100,000 Euros.

QUESTION: So you owe the interest onthe leveraged amount too? SHAUN: Yes.

It's on the leverage amount,what the interest is calculated on.

So when we open that 100,000 euro position,we did that with 2,000 on 50:1 leverage, or we did that will 1,000 on 100:1 leverage.

But you're not paying and receiving interest on your margin amount, you'rereceiving it on the leveraged amount.

Or paying it on the leveraged amount.

QUESTION: So to do that with MBTrading I'd have to do two blocks.

? SHAUN: No, because the interest is thesame.

You have a 100,000 position.

QUESTION: Yeah but to leverage thatmuch don't I have to double my.

? SHAUN: Yes.

So instead of using 1,000dollars, you use 2,000 dollars to open the one lot trade.

Okay, so, rollover is sevendays a week.

But we know that trading doesn't happen on the weekend.

So inForex trading really happens from Sunday afternoon to Friday.

But this is more of atechnicality, so really the only important days are Monday, Tuesday, Wednesday,Thursday, and Friday.

But they need to charge interest for seven days, eventhough these are the five days that are important.

So what they do is they chargeone day of interest on these days, and then Wednesday by convention and nogood reason, you get charged the interest for Wednesday, Saturday, and Sunday.

QUESTION: Why don't they do thatMonday? SHAUN: I don't know.

Why don't they do itThursday? QUESTION: Or why don't they spread itout across the week evenly? SHAUN: Yeah, why don't you pay one anda half days? That's just the way it is.

So this is referred to as triple rolloverWednesday.

QUESTION: And that's for the pastweekend, right? SHAUN: No, it actually has nothing to dowith weekends.

If you to decide to.

Okay, rollover occurs precisely at 5pm EST.

Sowhen you look at the charts of most brokers, it is based on broker time, butthe Forex industry by convention, this is the start of a new day.

So 5pm EST onSunday is actually the start of Monday.

5pm EST on Monday is actually the startof Tuesday's trading day.

And Tuesday's trading day concludes at 4:59PM onTuesday.

QUESTION: But on Wednesday you getcharged for the past Saturday and Sunday? SHAUN: Even if you didn't have a tradeopen.

If you decide, very poorly, at 4:59 on Wednesday that you're going to opena trade.

Let's write this down.

Wednesday, 4:59 PM open trade.

Wednesday at 5:01 PM, you close the trade.

A total of two whole minutes, youare either going to earn, or pay, triple rollover.


So it has nothing to dowith the last weekend.

They just charge you three times for whatever happens onthat day.

SHAUN: Yeah.

It's a market quirk.

If youhold that position precisely at 5:00 PM, you owe interest.

If you do not, you donot owe interest.

If you had the trade open for 23 hours and 58 minutes, butyou closed it before 5 PM, no rollover.

QUESTION: No triple rollover.

SHAUN: But if you have it at 5 PM, triplerollover.

It's the same concept on Monday, Tuesday, Thursday, Friday,except it's only single rollover.

QUESTION: What's to stop people fromopening trades for 2 minutes every Wednesday? SHAUN: Lots of people try that.

And itdoesn't work, because of spread costs.

You notice that rollover rates are so tinywe're talking about.

01% per annum, divide that by day and it's a silly amount.

It's so negligible that you don't really care.

There are exceptions.

There'sgolden week, and this involves the yen.

There are days where triple rolloverWednesday becomes 9x Wednesday, and you earn the interest for two weeks oftrading.

QUESTION: Do brokers just do that to getpeople to trade with them? Is that a just-for-fun thing or is there an actualreason? SHAUN: It's because Japan actually shutsdown for two weeks.

So anything involving a yen pair in May has goldenweek, where you have monster rollover day.

That's just the way it is.

People dotry and take advantage of it.

When interest rates were higher a couple ofyears ago there was a big differential between the pound and the yen, wherethe pound had an annual interest rate of 5.

25, and the yen had an annual interestrate near 0, as it still is today.

I think today it's.

1, but the point is that therewas a massive difference of 5%, and you could earn that on a leverage position.

QUESTION: [inaudible 00:14:38] SHAUN: Yeah, it does.

Because peoplewant to earn this money.

And this is what drives currency markets, is the actualshift in the interest rates.

People chase yield, so if I can open an account in GBPand I can earn 5%, if I'm holding yen that's looking really attractive to me.

I mightconsider the idea of converting my yen into pounds so that I could make thismoney.

This is actually referred to as a carry-trade.

And it's the idea of using leveragedmoney to earn the difference in interest rates.

It's possible, and it can be lucrative,but the problem is that it depends on your timing of exchange rates.

If you expectthat – think of a realistic scenario today – let's say the ECB decides to reversecourse, and this is not likely to happen at all, but right now they're trying to keeptheir interest rate at almost 0.

Let's say they decided to stop intervening in themarket and to charge a real interest rate.

The euro interest rate would go throughthe roof, which motivates people to put their money into Euros instead of dollars,yen, Australian dollar, whatever.

If you expect that trend to continue for severalyears, then that's a really good motivation for actually buying the currency, becausenot only are you going to earn the increasing differential in the currency, butmore people are likely to follow the trade.

The higher an interest rate is the morelikely people are to buy that currency.

That was actually the big reason behindBrazil's hot market, as of about 2 years ago interest rates were 13-14%.

Everything was appreciating through the roof, so you could buy the Brazilian realand sit back and know that you were going to make 14% in reals.

The problemis that if you top the market, like you did at 14%, you've earned 14% in reals andthen the price plummeted by 30%.

Timing is critical.

But that's the fundamentalreason the market exists.

That's why people trade currencies.

Not just forexchanges of payments, but for speculation.

That's entirely why peopleparticipate.

Because it's basically free money.

And there are all sorts ofexamples.

Oddly enough, in Poland most of the mortgages are denominated inSwiss francs.

The reason was that the Swiss had a very, very low interest ratecompared to what the Polish zloty was charging at the time.

If you could pay halfpercent, why are you going to pay five percent to have it denominated in zloty?The reason is because the Swiss franc has been appreciating for several years,and now half of Polish homeowners are severely under water because the value oftheir loans has appreciated by 20-30%, and they only make their income in zloty.

That's the risk of the market, and those are real world examples of why peopledecide to participate and why rollover is really important.

This is the electronicform of how it applies to our traders, our customers speculating in markets.

Thereal mechanics behind it are more tangible, like in the mortgage example.

Seven days a week, rollover, timing, I think that's everything.

Do you guys haveany questions on it? QUESTION: So is it common forstrategies to try to keep track of "Oh I wouldn't make money right now, so I wantto hold my trade at least until I hit my interest point for the day"? SHAUN: You could, but it's a silly risk.

Ifyou think that it's dangerous to be in now, you're going to stay in risking in theEurodollar an average of 120 pips of movement so that you can capture theequivalent of quarter pip.

QUESTION: Is that something that astrategy.

your current interest rate.

Because that's something the strategyhas access to at the market level, to be able to go out and query that.

So it has tobe fed that value from some other source, which means it has to.

SHAUN: Nope, it just has nothing to dowith back testing.

Nobody makes assumptions about rollover; it's notpresent on MetaTrader on a historical basis.

It is available in Real Time, and Ican show you guys where to find that.

It's not something that most people look at aspart of a strategy.

It is an important part, but it's not.

It shouldn't be the maker orbreaker.

It should kind of a little bit of juice.

You use it to pad margins a little bit,where it might be a drag on performance.

It should not be the primary reason whyyou're entering a trade now, at 4:59, so you can capture the tenth of a pip ofinterest cost, and you pay two and a half pips in the process.

The one thing that Ialso wanted to point out too is that everything I explain is kind ofhypothetical.

So you either lose.

14 %, or you make.

14% on an annual basis.

Well,in reality, that's not how most brokers work, and it's a good way that they padtheir margins.

This is how they make a slight amount of money for traders thataren't trading, is the difference in the rollover rates that they charge.

In theexample that I sent you, and assuming that we all did MetaTrader and it was aperfectly equal market, you would see that buying costs you.

MetaTrader showsyou dollars, but I'm just going to put it in a percentage.

This one has 0.

01%, andthis one would be -0.


This assumes that you're buying.

If you net that out youwould expect the total return to either be -0.

14% for buying, or selling to be 0.


But what happens most of the time is that everything gets skewed against you.

Sothis becomes a bigger number, it might be something like 0.

2%, and this onebecomes a smaller number, like 0.


I'm making this up, it's totally depended bybroker.

QUESTION: So you're saying that thebroker does this? SHAUN: Yeah.

It can be the broker; it canbe liquidity provider behind the broker, but yes.

The interest rates are market set,and then they get shifted and obviously someone is earning that differential.

QUESTION: So obviously these are withinthe bounds of legal priorities based on trading rules and.

? SHAUN: Yes.

QUESTION: They can slide it by a coupleof points? SHAUN: It is a cost, and I don't know ofanybody that discloses it.

I don't know who the ultimate beneficiary is, to behonest.

QUESTION: Well, the broker.

SHAUN: That is my assumption, is thatthe broker is making that.

And if they net their trades, they should be capturing thatdifference.

If you have 50,000 clients and most of them are piled into the Eurodollar,there's only going to be a certain amount net exposure.

You're only going to havemaybe 10% of that total difference is actually long or short.

So you can net outthe difference between these two, and keep all of it.

I mean that's not superlucrative, but it's money sitting there and they take it.

QUESTION: A dime times 50,000 islucrative.

SHAUN: It adds up.

QUESTION: Especially when it's allelectronic.


QUESTION: This may sound behind thetime, but I thought that politically they were pressuring the Eurozone to ease? SHAUN: They are.

QUESTION: But they are already waybelow the dollar so.

? SHAUN: Yes.

Well, the target headline ratein the Eurozone is 1.

25%, which is the result of the central bank intervening.

They're buying Spanish bonds, Italian bonds, basically the bonds that literallynobody wants; they're buying them so that the interest rates go down.

And thenin overnight lending, the markets are reacting to that.

Maybe if I'm going to loanmoney, you have to make the call for your business, for your multinationalcorporation and decide do I want to tie up money and jump dead for a year and getsix percent in Spanish bonds, or do I want to loan it to the ECB directly and get paidalmost nothing, but at least I know I'm going to get my money back.

QUESTION: Well it depends on how longyou're going to depend on being in it, and what you think the future is going to turn.

If you think that's going to turn, then go ahead and camp on it now and get it fornothing, if you can afford to be in it that long.

SHAUN: Yes, that's why there are interestrate curves.

That's a whole different subject.

But there's an interest rate curveand it always, well it's supposed to look like this.

Usually it looks more like that,where you have.

So if you lend for a day, and let's use the US Treasury market asthe simplest example, here are bills.

Bills are anything with about a 90 day coupon,so you can loan money to the treasury for a month, 90 days, six months, then youcan buy a one year treasury note, a two year, a five year, and a ten year.

Eachduration is supposed to get higher, but the further out you go, and then the 30 isgoing to be something like that.

The further out you go, you're supposedto get a higher rate of interest, but it's going to be rather negligible compared tothe duration.

The difference between overnight and three months is prettysubstantial.

The difference between a 10 year and a 30 year, hypothetically, issupposed to be more substantial, but obviously the time involved is almostbeyond comparison.

That's why in the example for rollover I cited that theovernight rate is this.

Because that's what you're using in the Forex market, butwhat people are really looking at when they're deciding whether or not to takeout mortgages or to loan money in different sovereign bonds, they're lookingat one year yields, 10 year yields.

QUESTION: It almost seems like it doesn'tmake sense to go past 10 years, because three decades is a long time to tiesomething up.

SHAUN: In that market I would agree.

Butthere were people in the 1970s that caught the US treasury in the height ofthe stagflation when interest rates in the US were at 14%, where they loanedmoney to the US government when the short term rates were actually inverted.

The yield curve actually looked like that, and people were taking the real easymoney over three to six months earning 17%, but the smart money blocked upthose interest rates at 14% for 30 years.

They made 14% per annum, compoundedfor 30 years.

The guys who bought the 30 years made a killing and absolutely asclose to risk free as you could get at the time.

Today I would argue that's suicidebecause I don't think the dollar will be around in 30 years, but that's a differentstory.

QUESTION: When do these costs getcalculated? So every day at 5:00 PM they say "You gained 2 cents" or whatever, butwhen did that fee get charged? SHAUN: Interest rates are a reallycomplicated subject and they're actual the result of a huge scandal right now that Iknow none of you know about, and none of the people I know know about, buteverybody should be up in arms up and it's Libor scandal.

Libor is whereovernight interest rates are set.

It's not a free market and it's actually voted on by agroup of, I think, 30 banks.

It's all the normal culprits.

The people that aredespised, and rightfully so, the Goldman-Sachs of the world, theBarclays, RBS, Bank of America, any bank that you've heard of that's internationalthey're probably one of the banks that set the Libor rate.

So they all get to vote anddecide what the interest rate is for the US dollar tonight.

When they set the ratethat's what every bank in the world uses to set it's overnight lending rate.

QUESTION: Do they just pull it out of thinair or do they base it on something? SHAUN: They pull it out of thin air.

Theysay "I think it's this, I think it's this" and there is a formula for we're going to throwout the most extreme ones and we're going to go with the ones that representthe middle.

It's the most important market in the world because it affects everythingthat connects the money.

It affects stocks, it affects real companies, itaffects bonds, it affects mortgages, it affects currencies, it affects everything.

What happened this summer was the Bank of England actually got caughtencouraging Barclays to nip the Libor rate.

As you can imagine, banks have astrong interest in voting whether the Libor goes up or down, because that isgoing to affect all sorts of things.

Like how much do they have to pay savers inthe CDs, how much do they have to charge for a mortgage, how much arethey going to lose if all of the mortgages that they've sold out over the last decadeto non-existent people, or people who have a pulse and no income, if theinterest rates go too high they are likely to default.

They have all sorts ofmotivations for keeping those interest rates as low as possible to benefitthemselves, and that's what happened.

The banks have this big audit trail ofcolluding with each other to say you vote this, I vote this, you vote this, I vote this,with the effect of pushing the overnight rates down and stealing, effectively, fromsavers.

It's not some conspiracy theory, it's all in Financial Times and it was amassive scandal in England.

In the US most people have not even heard of it,even though we're all the victims of it.

QUESTION: When did all of that start? SHAUN: I don't know when Libor started,but it's been the convention for at least 30 or 40 years.

It stands for the LondonInner Bank Open Rate or something like that.

Anyway, it's set in London butobviously that doesn't really matter anymore because all the banks areinternational.

That's the effect though; it's really just a committee.

QUESTION: With no governmentregulation or anything like that? SHAUN: Actually, it was with the activecollusion of the Bank of England and the Federal Reserve.

They were encouragingall of the banks to keep the interest rates low because it happens to align with thepolicies of said central banks.

There's many opinions out there that the centralbanks exist for the benefit of the banks that are on their committees that ownthem anyway.

QUESTION: So what should be thedeterminant of it in a perfect world? SHAUN: The free market.

If I want to loanmoney to Joe, it should be bid and ask.

If I want to receive 5% interest on my USdollar deposit, then I should have the ability to sell it.

QUESTION: Demand and supply.

SHAUN: Yeah.

It's not a market.

QUESTION: How did we get away fromthat into this? This seems like OPEC or something.

SHAUN: Yeah, that's basically what it is.

It's the same thing.

QUESTION: Yeah, I'm just ignorant aboutit.

SHAUN: Most people don't know aboutLibor.

It's probably the most important financial organization that you've neverheard of.

QUESTION: The best kept secret.

SHAUN: And I'm sure that's not acoincidence.

QUESTION: So if you Google this, youwon't find out anything you just said? SHAUN: Yeah, type in Libor scandal.

Youwill see it.

QUESTION: And the FBI will be knockingon your door.

QUESTION: So how is it kept secret? SHAUN: It's not kept secret.

QUESTION: It's not advertised.

SHAUN: It's just most Americans don'treally.

What's a Libor, what's an interest rate, you know? It's just not somethingthat apparently the American media finds worthy of news.

QUESTION: Well, it's probably a little bitof collusion between the media and the market.

SHAUN: I'm not going to be on theInternet advocating conspiracy theories.

But I will say.

QUESTION: Oh, it's a theory, is it? Youwere the one who said conspiracy.

SHAUN: I'm just saying Libor exists, that'sthe structure, draw your own conclusions.

Do you guys have any otherquestions? Rollover, Libor, interest rates? QUESTION: Now that I'm verydisheartened, no, thank you.

SHAUN: Yeah.

Hang your heads, go cry.

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