WHAT DOES ROLLOVER MEAN?
The interest received or paid for keeping a currency spot position overnight is known as rollover. Because forex is traded in pairs and each currency has an associated overnight interbank interest rate, each deal includes two distinct currencies and two different interest rates.
The term describes the interest added to or deducted from a trader’s account for positions maintained “overnight,” or after 5 p.m. ET.
Now that we understand what it represents let’s discuss how it works in forex.
How does it work?
The difference in interest rates of the two currencies will be earned or paid while a forex position is open. They are also known as currency rollover rates or forex rollover rates. The position will be credited if the interest rate on the long currency is greater than the interest rate on the short currency. If the interest rate on the long currency is lower than that on the short currency, the position will also result in a debit.
Take a long trade on EUR/USD as an example. You will be responsible for the difference if the EUR overnight interest rate is lower than the USD overnight interest rate.
The roll rates need to be closely monitored by traders who want to hold deals overnight.
Some interest rate differential-focused strategies, such as carry trades, try to benefit from favorable rollover rates by holding a long position in the currency with a high-interest rate and a short one in the currency with a low-interest rate.
Trades may be closed before 5 pm ET to avoid paying a negative roll, as rolls are only applied to positions that are still open.
It is important to stay up to speed with the Central Bank Calendar to track when these events occur since changes in interest rates may cause significant adjustments in rollover rates.
THE FOREX ROLLOVER RATE CALCULATION
Traders need the following three elements:
- The position size
- The currency pair
- The rate of interest for each currency
The result of this computation often provides a rough estimate. However, because the central bank rates are target rates and the rollover is a tradeable market, the actual rollover will vary slightly depending on market circumstances that incur a spread.
To calculate the daily rollover cost (AUD/USD 0.72), let’s look at an example:
1.) 10k lot position size
2.) Long AUD/USD currency pair
3.) 1.5% annual AUD rate, 2.5% annual USD rate
- Earn 10,000 AUD X 1.5% = $150 AUD every year. AUD 150/365 = 0.4109 AUD upon rollover.
- Pay 7,200 USD x 2.5% to get 180 USD a year. $180/365 = 0.4932 USD
- Convert AUD 0.41095 in interest earned to USD. 0.41095*0.72 = 0.2960 USD
- Subtract the amount made from the amount spent = 0.2960-0.4932 = -0.1972 USD (rollover cost)
The rollover rate is the difference between the long and short currency interest rates.
In the case above, the trader would have paid a debit to keep that position open every night. Carry trading techniques are forex trading methods designed to generate daily interest. Here is an example of a trader who made money.
The trader believed that buying AUD would lead to an increase in value. Instead of exchanging it for USD, they choose to exchange it for EUR. Here is a sample trade for 10,000 (EUR/AUD 1.60).
1.) 10k lot position size
2.) Currency pair: EUR/AUD, short
3.) 1.5% annual AUD rate, 0% annual USD rate
- Earn 10,000 x 1.6 = 16,000 AUD x 1.5% = 240 AUD annually. AUD 240/365 = 0.65 AUD at rollover
- Pay 10,000 X 0% = 0 EUR yearly.
- Convert AUD 0.65 in interest to EUR. 0.65/1.6 = 0.41 EUR
- Subtract the amount made from the amount paid = 0.41-0 = 0.41 EUR (rollover gain)
WHEN IS IT BOOKED?
It is scheduled at 5 p.m. ET. At 5:00 pm, a position opened at 4:59 will be subject to rollover.
It occurs around 5:00 p.m. in the United States.
It occurs at 2:00 p.m. in the UK (GMT).
When it comes to Australia, it happens at 9:00 am.
How do banks keep track of the weekend?
There is no rollover on Saturdays and Sundays since most banks worldwide are closed these days, but interest is still applied. The FX market records three days’ rollover interest on Wednesdays to reflect that. With reference to the AUDUSD transaction from earlier, a trader who retained that position on Wednesday at 5 p.m. ET would pay a loss of -.1972 x 3 = 0.59.
3 TIPS TO KEEP IN MIND
Traders may take advantage by following these simple guidelines.
- Positions must be closed before 5 pm ET. When trading across pairings or emerging market currencies, this would be more relevant if you knew the rollover rate was expected to be very negative.
- Keep positions open if you wish to continue the trade, and know that the rollover rate is most likely favorable.
- Watch the central bank’s schedule to see when rollover rates could change significantly.
This post is originally published on EDGE-FOREX.
