Forex Rollover is when interest is either earned or paid for holding a currency position overnight. Whether a debit or credit will be applied to your trading account depends on the currency pairs that you are trading – which you are buying and selling.
Since all currency trading is done in pairs, the value of one currency is always considered relative to that of another. So, the amount of interest that you receive will be based on the difference in the prevailing interest rates of the two countries the currencies belong to, when the rollover occurs.
In simple words, you will be paid interest for each day that you hold a high interest-bearing currency and will be charged interest for each day that you hold a low interest-bearing currency.
Rollover Rate and its Calculation
While trading forex, you borrow one currency to buy another and the interest that you need to pay or receive for holding an open position overnight is called the rollover rate.
Rollover rate is calculated using the formula:
R = (BC – QC)/365 x E
Where BC is the interest rate of the base currency, QC is the interest rate for the quote currency, and E is the exchange rate.
The base currency is the first currency in a pair, and the quote currency is the second one. The base and quote currency rates form a type of short-term lending rate of the banks in the countries to which the currencies belong.
What does Rollover Rate Indicate?
Rollover rates convert the net interest rate of the currencies being traded against each other into a cash return for holding an open position. The interest fee associated with the rollover is calculated by taking into account the difference between the interest rates associated with the currencies being traded.
So, if the rollover rate comes out to be positive, it will be a gain for the trader, while if it is negative, it will be an added cost for you.
Rollovers generally mean that a particular position has been extended at the end of a trading day, without settling. Most positions are rolled over on a day to day basis, till they are settled or closed. A large number of these rollovers occur in the “tomorrow next” market. This means that they are assigned to be settled the next day and are extended till the next trading session.
How Rollovers Occur in Forex Trading
Forex exchanges usually show the rollover rate. So, you usually don’t need to calculate it.
Let’s take the example of the NZD/USD pair. Now, let’s assume that at the time of opening the position, New Zealand’s interest rate stood at 4%, while the US interest rate was 1.5%. Since, you hold NZD, you are in a good position, since the interest rate differential is in your favour. To be exact, what your position will earn will be 4% - 1.5% or 2.5%. Now, if you hold a standard lot worth $100,000, the 2.5% differential in your favour means that you could make $2,500 by holding the position for a year.
Of course, this is much simpler said than done. Firstly, currency prices will inevitably fluctuate through the year, with potential for fluctuation of 20% or more during a 12-month period. Now, if the NZD begins to fall against the USD, you might lose more than the 2.5%. However, traders don’t usually take long positions as long as one year. What they attempt to achieve through the forex rollover strategy is daily gains, similar to carry trade.
So, take the USD/JPY pair. Now, let’s assume that at the time of opening the position, Japan’s interest rate stood at 0.25% per annum, while the US rate was 2.5% per annum. Now if you open a short position with the standard lot of 100,000 at 118.50 (exchange rate), your rollover rate would be:
100,000 (2.5% - 0.25%)/365 x 118.50
So, you stand a change to gain $5.20 per day through your open position.
Potential Benefits of Rollover
Although the daily interest cost or premium is quite small, if you are planning to hold a certain position for a long duration, you should consider the interest rate differential. There is a possibility that over time, you might buy a currency and make money from it, even after selling it at a lower rate. That is, if the currency you previously had gave a higher yield than the one you went short on.
Getting rollover credit could be an additional form of income, apart from the regular capital gains. Due to this, you might be able to set up trades to make the most of capital gains as well as income from interest.
A possible day trading strategy can involve allowing positions to stay open for a bit longer, to increase the chances of receiving interest income. Swing trading strategies can be tweaked to take long term positions in currency pairs that include high interest rate currencies.
Apart from this, if you expect a particular currency to stay flat for the entire year or end the year at their current values, you could again take the advantage of interest rate differential.
Some Things to Note
Remember that the interest debited or paid is done on the basis of the total value of the trade and not only on the trade margin. For example, if you are holding one standard lot of EUR/USD, you will be debited or credited interest on US$100,000, and not just on the margin that has been put up.
Another myth that needs to be debunked is that rollover is not a fee for using leverage. Many traders are of the view that if an amount has been debited in the name of rollover, it is actually the cost of leverage that the broker has provided. This is completely untrue. The amount debited or credited is solely based on the difference between the interest rates of the currencies in the pair being held.