Forex Brokers With Interest Of Margin: payable - How Leverage & SWAP Works?

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Trading on margin involves borrowing money from a lender to leverage one’s position in the market. The Forex market has a prescribed set of rules and limits regarding trading and has a particular set of limitations on how a trader can open a position in the market. In its pure form, Forex trading only allows traders to hold positions or market orders in multiples of standard lots. Therefore, to hold one standard lot on the EUR/USD currency pair in the market, a trader will be required to invest €100,000 or its equivalent of US Dollars according to the existing exchange rate.

In most cases, retail traders will find it hard to raise such a substantial amount of trading capital, which prevents them from holding any worthwhile positions in the market. Therefore, brokers allow their traders to enter the market with far less money by offering the option of trading on margin. For example, if a trader only has access to €1000, the broker may provide leverage of 1:100 to enable the trader to leverage his position and buy or sell a standard lot of the EUR/USD currency pair. Of course, using such a high amount of leverage will induce wild swings in the profit and losses, as the trader is essentially holding a large position using a small trading capital.

A 1:100 leverage on a standard lot means that a trader is borrowing €99,000 on top of his own €1000 to open a position in the market. Irrespective of the outcome of the trade, a trader is fundamentally borrowing a staggering amount of money from his broker to hold a position in the market, which means that the broker is investing their money in a trade. Of course, the broker will employ minimum margin requirements and margin calls to protect their investments against market losses, which means that the trader will face a margin call if a position moves against him and the account equity reaches the minimum margin requirements. The minimum margin requirement varies according to the leverage used by the trader; therefore, a 1:100 leverage amounts to a minimum margin of 1%, while a 1:50 leverage amounts up to a minimum margin of 2%.

Since the broker is lending money to a trader to open a position in the market, they will require some fees or compensation for the money invested in the market. The broker might lend their own working capital to a trader’s position, or may alternatively rope in a lending institution such as a bank to increase the trading margin. Either way, trading on margin blocks the funds lent by the broker, which requires the trader to pay interest on the borrowed margin. The interest, or more commonly known as SWAP, is accrued for every overnight trade, as the interests are charged after the end of the New York trading session.

SWAP and interest rates are dependent on the currency pairs, which can result in both positive as well as negative SWAP. SWAP rates are determined by the base currency used for trading and the actual difference between the interest rates of the currency pairs invested in the market. For example, if a trader uses the US Dollar as the base currency to go long on the NZD/CHF (New Zealand Dollar vs. Swiss Franc), the SWAP rates are calculated by converting the USD to the CHF and then weighing up the NZD against the USD. Since the NZD has a stronger base rate (2.5%: at the time of writing this article) when compared to the negative rates of the CHF (-0.75%), traders going long (buying the pair) will enjoy a positive SWAP, while traders going short (selling the pair) on the pair will experience a negative SWAP.

Therefore, traders have the potential of making more money by going long on the NZDCHF pair by enjoying the positive SWAP as well as making money on any possible upward movement of the currency pair. Alternatively, if a trader shorts the NZDCHF, he will have to pay a negative SWAP fee or interest on his position, even if the market moves in his favor for potential gains in the market. SWAP rates are applicable for all traders who are trading on margin and typically hold their trades overnight.

Reprinted from Forexbonuses, the copyright all reserved by the original author.