21. What is overnight interest?
The concept of overnight interest
Overnight interest is a term commonly used in online forex trading. Rollover, swap fee, overnight funding, in fact, all refer to the same thing. Generally, if the investor has an open position at 5 PM EST (summertime), there will be an overnight interest “cost” following settlement occurred. Such “interest” includes the “rate differential” of that trading product (currency pair) as well as the financing cost of the trading platform.
Investors should note that they will pay or receive interest depending on the products being traded. When investors are trading a currency pair (that means two currencies actually), there is an interest rate difference between the pair (different currencies have different interest rates). And, if investors buy the currency at a higher rate, they may have a chance to get overnight interest “income”. However, vice versa, they may have to pay the overnight interest “cost”.
In addition, overnight interest is charged even when the market is closed, including weekends and holidays. Some trading platforms will charge three days of interest together on Friday. But in practice, the forex market is following the T+2 settlement system, so in forex trading, the “3-days interest” is often charged on the open positions on Wednesday.
Although there is a formula for calculating overnight interest theoretically, the actual interest amount cannot be simply calculated due to the financing costs of different trading platforms, change of different bank policies, and the short-term fluctuations in interest rates in the money market.
However, investors can look up the overnight interest information on the trading platforms directly, and some brokers even provide a detailed list for investors as reference.
What is carry trade?
The term Carry trade means that investors borrow assets(money) at lower rates to buy other assets with higher yields. In forex trading, a carry trade is a practice of buying higher-yield currencies for long-term holding. For example, when investors buy AUD/JPY, in effect, they borrow Japanese yen and buy the Australian dollar, which means they will pay less interest cost on the yen and receive more interest income on the Australian dollar. If such rate differential is wide enough, the carry trade strategy works.
The carry trade is a traditional strategy in the forex market, but with the extremely low-interest rates these years, the room for carry trades is becoming less meaningful.
Next Article: 22. What are Spread and Pips?
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Risk Warning: The above content is for reference only and does not represent ZFX’s position. ZFX does not assume any form of loss caused by any trading operations conducted by this article. Please be firm in your thinking and do the corresponding risk control.