Traders commonly interpret payment for retaining an open position overnight (aka Swap) as an additional fee, which they must pay to their broker, since Swap is negative for most of currency pairs. In other words, it is a debit to customers’ account. However, for some currency pairs it is positive. Therefore, sometimes traders try to make a profit on FOREX market at the end of trading session on Wednesday, when a triple Swap is charged.
In order to realize what events take place on FOREX market right before Swap is charged, let’s define what is Swap. Swap is an arrangement of two opposite side contracts, one of which closes previously opened trade and the other reopens an identical trade, but at a different price level, so that it takes into account the payment for retaining that position. Hereby, banks and other liquidity providers carry out daily settlement procedure.
Traders, who try to make money using a Triple Swap strategy, usually act in the following way: they buy Australian Dollar against US Dollar (since interest rate on AUD is higher) 20-30 seconds prior to Swap being charged, that means, they go Long AUDUSD without giving any consideration to the direction of the trend. In 10-15 seconds after SWAP is charged, traders liquidate that order. It is important to understand, that between the initiation of the transaction and its liquidation, i.e. for 40-50 seconds, a full cycle of settlement is carried out (as described above).
If at a specified time price has soared or remained practically unchanged, the client by closing the transaction receives either positive or zero gain along with a positive swap. In case of adverse price movement the financial result of the transaction will obviously be negative. However, the client will presumably receive income in the form of difference between positive swap and a loss on the transaction plus the broker’s fee.
Unlike Triple Swap trading – which is conducted in very short time frame, Carry Trade is an investment strategy. Carry Trade is also based on an idea of borrowing a low interest rate currency and investing the proceeds into a high interest rate currency. The gain comes in a form of difference between those interest rate yields. By choosing this method of investing, trader accepts the risk of adverse prices movement on a financial instrument.
Currently, the interest rate for Australian Dollar is higher than the rate for U.S. dollar. Therefore, volume of long positions on AUDUSD pair considerably exceeds volume of short positions. At the closing of each trading session long positions on AUDUSD are liquidated, resulting in a large amount of sales in Australian dollar. That consequently leads to decrease in the level of BID quotes which widens the spread, while the level of ASK quotes remains practically unchanged. Then, at the time of reopening of those positions, when Australian dollar is repurchased, BID price rises and restores the spread to its previous levels.
On ECN BID and ASK prices are formed by the so-called “Depth of Market” also known as Level 2. This technology combines information received from Liquidity Providers with broker’s own book of limit orders, so that available volumes at various price levels form liquidity pool.
Depth of Market at any given time looks as follows:
Buy and Sell orders of particular currency pair are grouped according to the price, while charts only display the best Bid and Ask prices.
In order to conduct the procedure of session closing – settlement, it is necessary to close all open positions and then reopen them at the price, which will take into account Swap. Recall, that one closes deals with opposite side deals, that means, that for closing Buy order bank should sell previously opened contracts. It can be done either by matching against a Market order (Market Order Sell) placed by other broker’s clients, or by matching with Pending orders (Buy limit) placed by Liquidity Providers and clients.
Hereby, when an aggregate volume of long positions significantly exceeds the volume of short positions, at the time of settlement Depth of Market looks like this:
A large volume of Buy Limit orders from Liquidity Providers (Bid prices for broker’s clients) is consolidating at the price level, which is different from current (the volume of 120 lots at the price of 0.9700). Buy Limit orders placed by broker’s customers represent a small part of total liquidity (orders at the price from 0.9745 to 0.9741).
As previously mentioned, at each point of time the best Ask and Bid prices are displayed on the charts. At these prices orders are executed every given moment of time. However, one should not overlook the fact, that those volumes which are available for buying or selling of a currency at these prices might be miniscule. And if there is a large volume order, the price of bargain conclusion will be wide different. At the moment the best Ask price is 0.9746, the best Bid price is 0.9745. If during short period of time customers or liquidity providers don’t place any orders, the order Sell Limit with volume 1.5 Lots at the price 0.9746 (Ask price) will be matched with Buy Limit orders with total volume 1.1 lots (0,2+0,4+0,1+0,1+0,3) at the prices from 0.9745 to 0.9741 (Bid prices). The next available price will be 0.9700. Hereby, due to considerable difference between prices, there will be a spike on the chart.
Over the next a few seconds all the positions on AUDUSD will be reopened at prices that take into account Swap and Bid quotes will stabilize.
However, if the client has a low Margin Level, it is possible, that orders will be automatically closed according to Stop Out procedure. If price Gap occurs, all the orders will be closed at the next available price after Gap. As a result, client’s balance might become negative, than it will be adjusted up to zero.
A trader opened the order Buy AUDUSD with volume 31.10 Lots at 23:59 server time. In a few seconds after Swap is charged he closed the order. In spite of the fact, that the order was closed with the loss of -528.70 USD and trader paid the commission of -154.18 USD to the broker, credited Swap covered losses and resulted in a net gain of + 110.17 USD.
At the same time, in case of low liquidity in the market and low Margin level (when the volume of opened order was too large), trader might make not a profit, but loss, and lose a significant part or all of the deposit.
A trader opened order Buy with the volume of 25.40 Lots, the balance of his account was 5026 USD, Used Margin was 4951 USD. After abrupt movement the order was closed according to Stop Out procedure. The client made loss -11734.80 USD and paid broker’s commission -123.78 USD. There was no enough money on balance to cover the loss; therefore, the balance was adjusted at the broker’s expense.
Thereby, Carry Trade investing brings a guaranteed income only if the exchange rate of the currency pair remains unchanged. Applying Carry Trade, as well as any other strategy on Forex market, involves various risks, therefore, its use must be based on thorough market analysis.
Written by Katsiaryna Krauchanka, FXOpen financial analyst.