The Importance of Swaps & Spreads in FX
As a beginner trader, it’s easy to feel overwhelmed by all the advantages brokers promise to offer you. For instance, you may have found a forex account that boasts ‘tight spreads’ or ‘low swap fees’, but what exactly do these terms mean and how do they benefit you?
Swaps and spreads are two of the biggest forex trading costs you will come across. As they can affect your account balance significantly, it’s important to not only understand when and why you will incur these fees but how you can make them work for you too.
On this page, you can learn:
- What a spread is in forex, and how to calculate it
- The different types of spreads you may come across, and the benefits of each
- What a swap is in forex trading
- The pros and cons of swap fees
- How to locate swap fees within MetaTrader 4
What Is a Spread in Forex Trading?
In forex trading, the definition of a spread is the difference between the bid and the ask price of a currency pair. In other words, it is the difference between the price you must pay for a currency pair and the price you can sell it at.
For example, if the bid and ask prices for the EUR/USD pair are 1.1230 and 1.1231 respectively, the spread is the difference between the two. Spreads are measured in pips and, in most currency pairs, one pip is equal to 0.0001. So, in this trade, the spread would equal 1 pip.
Spreads are how non-commission forex brokers make money. As you are selling/buying your currency pairs to/from the broker, they profit off the difference in prices. This means that whilst a non-commission forex broker won’t take a percentage of your profits separately, the fee is simply built into your trade.
As such, the smaller the swap is, the more attractive that type of account/broker, as trading costs will be smaller.Are there different spread types?
The type of spread you will encounter will depend on the type of Forex broker you are trading with, and your account type. In forex trading, there are two types of spreads:
- Fixed spreads
- Floating/variable spreads
Fixed spreads, as their name suggests, are spreads that stay the same size no matter what. The broker simply creates a spread size for a certain forex currency pair, and you can expect this to be the same each time you trade.
Brokers who offer fixed spreads are either operating as a dealing desk, or as a market-maker (a broker who attempts to match client orders with liquidity-provider orders, and who take the opposite side of your trade if there’s no match).
In both cases, this leaves the broker as a sort of middle-man between you and the market. This is what allows them to create fixed spreads.
A typical spread under these conditions starts from around 1 pip for the EUR/USD (the lowest spreads are always on the EUR/USD pair) and rises gradually for other currency pairs, with spreads of up to 4 or even 5 pips for currency pairs such as GBP/CHF, or other exotic currencies
The Advantages of Fixed Spreads
Fixed spreads are a good thing, especially when it comes to fast-moving markets such as forex. Due to the market’s volatility, it can be reassuring to know the price of a trade before you place it. In addition, fixed spread accounts can usually be opened with a small initial deposit, which makes them perfect for beginner traders.
The Disadvantages of Fixed Spreads
In periods of high volatility, such as after news or data releases, trading with fixed spreads can lead to requotes and slippage. This is because the broker cannot adjust their spread to accommodate for large price movements, and so they have no option but to ask you to accept a new entry price.
Variable spreads are those which are always changing. These types of spreads are also sometimes called floating spreads and they are offered by non-dealing-desk forex brokers or brokers who use Straight Through Processing (STP) and Electronic Communication Network (ECN) technologies to get their quotes.
Under these conditions, the broker has direct access to the interbank market and will try to match the orders with orders from other market participants, such as banks, hedge funds, and even other brokers. Due to this, the broker has no control of the spread, as it will change in size due to market demands and volatility.
Usually, variable spreads widen when important economic news is released and during other periods of decreased liquidity such as public holidays and when the market is about to close.
The Advantages of Variable Spreads
Variable spreads are generally tighter throughout the day, which offers traders the chance to make more profit. With this type of spread, you are also unlikely to experience requotes, as the spread simply changes as the broker factors in market conditions.
The Disadvantages of Variable Spreads
The main disadvantage of choosing a broker, or account type, which offers variable spreads is that there’s no way of knowing how much a trade is going to cost you at a certain time. Variable spreads are also not suitable for scalpers, nor news traders, as spreads can widen significantly in a matter of seconds.
Zero or No-Spread Accounts
Some brokers advertise zero spread forex accounts. This sounds too good to be true and, unfortunately, it is. With this type of account, the spreads are not really zero, but they do tend to be small. In addition, with a zero spread account, you will be charged a commission on every trade that is opened, regardless of whether it is going to be a winner or a loser.
The main benefit of a zero spread account is that it allows you to know your entry and exit points exactly. It may also be a cheaper option if the broker is offering a low commission rate. However, most zero spread accounts with low commission have high depositing limits, making them unsuitable for first-time traders.
What Is a Swap in Forex?
When you trade forex, you are basically buying or selling a currency for another, with a view to ‘swap’ it back later with the broker. This is where the idea of swaps come from, as they are the fees you incur for holding your position overnight.
If you choose to keep a trade open overnight, you will either be paid or be charged interest on your position. The very definition of a swap is the difference between the different interest rates in a currency pair.
Do not take that definition word by word, though, as it is not really the exact arithmetical difference. Other factors are considered too, including the broker’s mark-up. Traditionally, swaps worked in the following way:
- If you hold a long position, and the buying price decreases, you receive swap interest
- If you hold a long position, and the buying price increases, you are charged swap interest
- If you hold a short position, and the selling price decreases, you are charged swap interested
- If you hold a short position, and the selling price increases, you receive swap interested
However, swaps are mostly negative these days, and that’s why they fall under trading fees. As interest rates are at exceptionally low levels, at the end of a trading day most open positions will result in charges. This cost is directly related to the volume of that open position.
Triple Swaps on Wednesdays
If you choose to keep a trade open overnight on a Wednesday, you will experience triple swap rates. This is because, whilst the forex market is closed on Saturdays and Sundays, the banks still charge interest. As trades take two days to settle (so trades placed on Wednesday will settle on Friday) this triple fee covers your rates for the weekend.
How to View Swap Fees in MetaTrader 4 & 5
At some high-quality forex broker sites, you will be able to find the swap rate of each currency pair listed in a table, or they may offer a swap rate calculator tool. More often than not, however, swap rate information can be hard to locate.
You can find the swap rates for your chosen forex broker within the MetaTrader trading platform. These are updated constantly and reflect the prices you will be charged that night. If you are still deciding whether a certain broker is right for you, and want to see the swap rates before deciding, you can simply enter MetaTrader via a demo account.
Follow the steps below to view swap rates in MetaTrader 4 and 5:
- Load MetaTrader 4/5 and login as normal
- Select ‘View’
- Click ‘Market Watch’ and then select ‘Symbols’
- Select the currency pair you want to see the swap rates for
- Select ‘Properties’ (on MT4), or ‘Specification’ (on MT5)
How is the spread calculated in forex?
In forex trading, the spread refers to the difference between the bid and ask price. It is measured in pips, and one pip is equal to 0.0001 of a currency. So, for example, if the bid price was 1.1201, and the ask price was 1.1203, the spread would equal 0.0002 or two pips.
Which forex broker has the best spreads?
For traders, the best spreads are simply those which are the lowest. However, traders also need to decide whether fixed or variable spreads are more suited to their trading style. You may also consider a zero-spread account but do note that although the spreads on these accounts are exceptionally low, the broker is likely to charge commission. Once you know which type of spread is best for you, you can compare forex brokers based on spread size/ commission rates.
How can I avoid swap fees when forex trading?
To avoid swap fees when trading forex, you need to close your positions at the end of the day. Swap fees are charged every weekday at 00:00 server time on MetaTrader 4/5 (GMT +2). This translates to 17:00 EST.
How long can you hold a position in forex?
You can hold a position for as long as you want, from minutes to days or even months. However, for each day you hold your position, you will be charged a swap fee. It is, therefore, wise to calculate how much you will be charged for holding your position for a longer period, before doing so.
Other educational materials
- How to Enter/Exit a Trade
- How Do I Make a Profit from Forex Trading?
- Forex Market Terminology
- Profit from Forex Trading Using Different Trading Styles
- How to Set Up an Expert Advisor
- HFT (High-Frequency Trading) in Forex Markets
Recommended further readings
- Counterparty risk for credit default swaps: Impact of spread volatility and default correlation. Brigo, D., & Chourdakis, K. (2009). International Journal of Theoretical and Applied Finance, 12(07), 1007-1026.
- “The market price of risk in interest rate swaps: The roles of default and liquidity risks.” Liu, Jun, Francis A. Longstaff, and Ravit E. Mandell. The Journal of Business 79, no. 5 (2006): 2337-2359.