Sabtu, 03 Maret 2012

How "Rollover" Works In The Forex Market

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What you are actually trading in the Forex market is a contract that requires one currency to be exchanged for another and delivered in two business days. For example, if I buy one contract of the EUR/JPY currency pair, I am buying 100,000 euros and selling the equivalent amount of Japanese Yen. This technically requires me to deliver the equivalent amount of the Japanese Yen side of the trade to the bank account of the party I am trading with. Conversely, the party I am trading with is technically required to deliver the 100,000 EUR portion of the trade to my bank account in two business days.

However, since we are trading for speculation, we do not want to make or take actual physical delivery of the currency. The platform that we are using in our examples, and pretty much any other retail Forex trading platform, will automatically roll this position over to the next delivery date if the position is held past 5pm NY time.

It is not really important to understand all of the details of the transaction since this is done automatically. However, it is important to understand that there is a U.S. dollar debit or credit made to your account for any position held past 5pm NY time to account for the interest portion of the transaction.

As with most transactions that involve holding or borrowing money, trading currencies also involves an interest payment or credit depending on whether you are the holder of a currency or the borrower of a currency.

If I buy the USD/JPY pair, which means I have bought U.S. dollars and sold Japanese yen, I earn interest on the U.S. dollars that I have bought and pay interest on the Japanese yen that I have sold in order to buy those U.S. dollars. The reason for this is technically what I am doing when I sell a currency, is borrowing that currency and then exchanging the borrowed currency for the equivalent amount of the currency that I am buying.

I am oversimplifying things a bit here, but the interest rates that you pay and receive on the currencies involved in the trade is two days worth of interest derived from the overnight interest rates of the countries whose currencies you are trading.

As discussed in Module 8 in the free course section of InformedTrades.com, the Federal Reserve sets overnight interest rates in the United States for U.S. dollars. Just as the United States has the Federal Reserve, other countries around the world have central banks that set the overnight rates for their currencies.

When trading Forex, if you buy the currency with the higher interest rate and sell the currency with the lower interest rate, you will earn money for holding a trade past 5pm NY time when the rollover occurs because the interest rate differential is in your favor. Conversely, if you sell the currency with the higher interest rate and buy the currency with the lower interest rate, you will pay interest when you hold the trade past 5pm NY time because the interest rate differential is not in your favor. If you open and close the position before 5pm NY time, nothing happens in your account as there is no rollover necessary.

As noted, we are trading a 2-day contract in the Forex market, so the interest that you pay or receive at rollover is 2 days interest, calculated on the interest rates as set by the central banks in the countries of the currency pair that you are trading.

Using our USD/JPY trade as an example, overnight interest rates in the United States are at 2.25% as of this writing and rates in Japan are at .5%.

As you can see, when trading the USD/JPY currency pair, if we buy the pair we are long (holding) U.S. dollars at an interest rate of 2.25% and we are short (borrowed) Japanese yen at an interest rate of .5%. In this example, the interest rate differential is in our favor by 1.75%, so we will earn interest if we hold this position past 5pm NY Time.

If we were to sell the USD/JPY currency pair, then we are short (borrowing) U.S. dollars at an interest rate of 2.25% and long (holding) Japanese yen at an interest rate of .5%. In this case, the interest rate differential is against us by 1.75%, so we would pay interest if this position were held past 5pm NY time.

I have tried to make the explanation of this concept as simple as possible. But to be honest, this is probably the most difficult concept for traders who are new to the Forex to understand.

Since this is one of the more complicated things to grasp about trading Forex, some firms take advantage of a trader's lack of understanding and charge more than they should when the trader is long the currency with the lower interest rate and pay them less than they should when the trader is long the currency with the higher interest rate. A nice feature of a Forex trading platform is that it is transparent in the way that the rollover is done.

To explain, if the number beside the currency pair and under the appropriate roll column has a positive number, this is the amount in U.S. dollars that will be credited to your account, per contract, for any position held past 5pm NY time. If the number is negative, this is the amount that will be debited from your account, per contract, for any position held past 5pm NY time.

Remember if you open and close a position before 5pm NY time, the position does not need to be rolled over, so your account will not be debited or credited.

As a quick example, let's say that I want to know the amount of interest that I will either pay or receive if I buy 2 contracts of GBP/JPY and hold that position past 5pm NY time. This may not be true with every platform, but if the platform you are using does not provide this information, I would suggest finding one that does. Scroll to GBP/JPY currency pair and to the Roll B' column of the platform to find the amount that will be credited per contract. Since in this particular example, I am trading 2 contracts I would earn double the amount for holding that position past 5pm NY time.


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