WHAT IS ROLLOVER?
Rollover in the context of forex trading refers to the interest that is either paid or earned when holding a currency position overnight. It is based on the overnight interbank interest rate associated with each currency. Since forex trading involves trading currency pairs, every trade involves two different currencies with their respective interest rates.
When you hold a forex position beyond 5pm ET, the rollover comes into play. If you are holding a currency pair where the base currency has a higher interest rate than the quote currency, you may earn interest on the position. Conversely, if the base currency has a lower interest rate than the quote currency, you may be charged interest.
In simpler terms, rollover is the mechanism through which traders receive or pay interest for keeping positions open overnight in the forex market, and it depends on the interest rate differentials between the currencies involved in the trade.
WHAT IS THE PROCESS OF APPLYING INTEREST RATES TO CURRENCY POSITIONS?
When you have an open forex position, you will either earn or pay the difference in interest rates between the two currencies involved. These interest rate differences are known as forex rollover rates or currency rollover rates. If the interest rate of the currency you are long (buying) is higher than the interest rate of the currency you are short (selling), you will earn a credit. Conversely, if the interest rate of the long currency is lower than the interest rate of the short currency, you will pay a debit.
For instance, let's say you have a long trade on EUR/USD, and the overnight interest rate for the EUR is lower than the overnight interest rate for the USD. In this case, you would pay the difference in interest rates.
Traders who plan to hold their positions overnight need to closely monitor the rollover rates. Generally, in normal market conditions, these rates remain relatively stable. However, during times of increased credit risk in the interbank market, rollover rates can fluctuate significantly from one day to another.
Certain strategies, such as carry trades, focus on capitalizing on positive rollover rates. These strategies involve taking a long position in a currency with a high interest rate while simultaneously shorting a currency with a low interest rate.
It's important to note that rolls, or rollover rates, are only applied to positions that are held open at 5pm ET. To avoid the risk of paying a negative roll, traders can close their positions before this time.
Changes in interest rates can have a substantial impact on rollover rates, so it's advisable to stay updated by referring to the Central Bank Calendar to track when such events occur.
CALCULATING THE FOREX ROLLOVER RATE
To estimate the rollover rate or nominal amount in forex trading, traders typically consider three key factors:
- the position size,
- the currency pair being traded,
- the interest rates associated with each currency.
Let's examine an example to understand how to estimate the daily rollover cost for a long position in the AUD/USD currency pair, with a position size of 10,000 lots and annual interest rates of 1.5% for AUD and 2.5% for USD.
First, the trader calculates the interest earned in AUD: 10,000 AUD * 1.5% = 150 AUD annually. To determine the daily rollover amount, divide this by 365: 150 AUD / 365 = 0.4109 AUD.
Next, the trader calculates the interest paid in USD: 7,200 USD * 2.5% = 180 USD annually. Dividing this by 365 gives the daily rollover amount: 180 USD / 365 = 0.4932 USD.
To convert the AUD interest earned into dollars, multiply it by the exchange rate: 0.4109 AUD * 0.72 (AUD/USD exchange rate) = 0.2960 USD.
Finally, subtract the amount earned from the amount paid: 0.2960 USD - 0.4932 USD = -0.1972 USD. This negative value represents the rollover cost in this example.
In summary, the rollover rate estimate is obtained by subtracting the short currency interest rate from the long currency interest rate. In the given example, the trader incurred a debit or rollover cost for holding the position overnight. However, it's worth noting that some forex strategies, such as carry trading, aim to earn daily interest by taking advantage of positive rollover rates. An example illustrating a trader earning a positive roll is also provided, involving a short position in the EUR/AUD currency pair.
WHEN ROLLOVER IS BOOKED?
Interest rates are applied to currency positions at 5pm ET. A position that starts at 4:59pm will have interest rates added at 5:00pm. A position that starts at 5:01pm will have interest rates added the next day at 5:00pm.
For people in America, this happens at 5:00pm.
For people in the UK, this happens at 10:00pm (GMT).
For people in Australia, this happens at 9:00am.
What happens on Weekends?
Most banks around the world are not open on Saturdays and Sundays, so there is no interest on these days, but the banks still charge interest on these days. To make up for that, the forex market adds three days of interest on Wednesdays. Using the AUDUSD example above, a trader that kept that trade on Wednesday at 5pm ET would pay a fee of -.1972 x 3 =0.59
What happens on Holidays?
There is no interest on holidays, but an extra day of interest usually happens two business days before the holiday. Usually, holiday interest happens if either of the currencies in the pair has a big holiday. So, for Independence Day in the USA (July 4) when American banks are shut, an extra day of interest is added at 5:00pm on July 1 for all US dollar pairs. If the day the interest to be added is on a weekend, then it gets moved to that Wednesday which may mean 4 or 5 days of interest.
3 WAYS TO USE FOREX INTEREST TO YOUR BENEFIT
Some simple tips can help traders make use of FX interest rates. Here are three that could help you include interest rates in your plan:
- End positions before 5pm ET if you know the interest rate is likely to be very negative…. this would be more relevant when trading cross pairs or emerging market currencies
- Keep positions open if you know the interest rate is likely to be positive and if you want to stick with the trade.
- Watch the central bank calendar to track when interest rates may change a lot.