Rollovers and Carry Interest

Rollovers and Carry Interest: Making Money for Making Money

In the last section of this tutorial you learned how you could boost your returns by using leverage. Now we’re going to show you how this leverage actually works, and the costs and gains that come with levered forex positions. These costs or gains are known as forex rollovers, or carry interest.

We said previously that when you use 50:1 leverage you put up $1 and the broker adds in the other $49 for a total investment of $50. When you use leverage, you are essentially borrowing money to invest in the forex market from your broker.

Rollovers

Traders “rollover” their position when they hold them overnight. Holding a position overnight is usually defined by holding them past the closing time for a particular broker, which can range from 4-6pm EST.

When you use leverage through the day, you are essentially borrowing money for that day. If you wish to hold the position overnight, then you’ll either gain or lose interest by doing so. Alternatively, traders who do not want to pay interest on their holdings can do so by selling before the day closes. Most forex brokers do not charge or add interest for holding a leveraged position through the day.

Simple Interest Mathematics

We’re going to have to do some mathematics to see how forex traders gain or lose interest in holding a position overnight, but it is a fairly simple exercise.

Previously, you learned that when you buy or sell (go long or go short) a currency pair, that you are swapping one currency for another. To make this very simple, you are essentially borrowing money from a bank in one currency, and depositing the cash in another bank in another currency.

If, for example, you were to purchase USD/CHF for 10,000 units, then you would be swapping Swiss Francs for $10,000. Thus, you would be borrowing CHF from a Swiss bank, and lending Dollars to a US bank.

If the borrowing rate in CHF is .25% per year, and the lending rate is .5% per year in the US, then you would earn .5% minus .25% per year for buying USD/CHF. Alternatively, if you were to sell USD/CHF, you would lose .25% per year to interest rates, as you would be borrowing US dollars at .5% and lending in Swiss Francs at .25% per year.

Carry Interest Example

Let’s say you did buy USD/CHF and held it for one year. Over the course of the year, you would have an interest expense of $25 from CHF borrowing, and a $50 gain from USD lending. The net gain would be $25 just for keeping the 10,000 unit position open for one year! For one day, we can divide this by 365 to get a gain of $.06 (6 US cents) in interest each day.

All things considered, the cost of carry is very small for many pairs, and hardly affects your trading balance—positive or negative. In future tutorials, we’ll explain how some traders make predictions about the forex market by using interest rates as a guide, and how others make their living just by accumulating rollover interest in the forex market.