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Old 04-25-2008, 04:20 PM   #1 (permalink)
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How Rollover Works in the Forex Market


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In our last lesson we wrapped up our discussion on the different order types available to forex traders with a look at the Entry order. In today’s lesson we are going to continue our discussion on the logistics of forex with a look at something which is known as rollover.

What you are actually trading in the
forex market is a contract which requires one currency to be exchanged for another and delivered in two business days. For example, if I buy 1 contract of EUR/JPY then I am buying 100,000 worth of Euros and selling the equivalent amount of Japanese Yen. This technically requires me to deliver the equivalent amount of Japanese Yen portion of the trade to the bank account of the party I am trading with. The party that I am trading with is then technically required to deliver the 100,000 EUR portion of the trade to my bank account in two business days.

As we are trading simply for speculation however, we do not want actual physical delivery of the currency, so the platform which we are using in our examples, and pretty much any other retail
forex trading platform, will automatically role this position over to the next delivery date if the position is held past 5pm Eastern Standard Time.

It is not really important to understand all the details here as this part is done automatically. What it is important to understand however is that there is a US Dollar debit or credit made to your account for any position held past 5pm Eastern Time, to account for the interest portion of the transaction.

As with most other transactions which involve holding or borrowing money, trading currencies also involves an interest payment or credit depending on whether you are the holder of a currency or the borrower of a currency.

What this means is that if I buy
USD/JPY which means I have bought US Dollars and sold Japanese Yen, then I earn interest on the US Dollars I have bought and pay interest on the Japanese Yen that I have sold in order to buy those US Dollars. The reason for this is technically what I am doing when I sell a currency, is borrowing that currency and then exchanging the borrowed currency for the equivalent amount of the currency that I am buying.

I am oversimplifying things a bit here but basically the interest rates that you pay and receive on the currencies involved in the trade, is two days worth of interest derived from the overnight interest rates of the countries whose currencies you are trading.

If you remember from module 8 of our basics of trading course in the free course section of
InformedTrades.com, overnight interest rates in the United States for US Dollars are set by the Federal Reserve. Just as the United States has the Federal Reserve, other countries around the world also have central banks which set the overnight rates for their currencies.

When trading
forex if you buy the currency with the higher interest rate and sell the currency with the lower interest rate, then you earn money for holding a trade past 5pm when rollover occurs, because the interest rate differential is in your favor. Conversely if you sell the currency with the higher interest rate and buy the currency with the lower interest rate then you pay interest if you hold the trade past 5pm, because the interest rate differential is not in your favor. If you open and close the position before 5pm then nothing happens as there is no rollovernecessary.

As noted above we are trading a 2 day contract in the
forex market, so the interest that you either pay or receive at rollover is 2 days worth of interest, calculated based on the interest rates as set by the central banks in the countries of the currency pairs which you are trading.

Using our
USD/JPY trade as an example, overnight interest rates in the United States are at 2.25% as of this lesson, and rates in Japan are at .5%.

As you can see here when we are trading the
USD/JPY currency pair, if we buy then we are long (holding) US Dollars at an interest rate of 2.25% and we are short (borrowed) Japanese Yen at an interest rate of .5%. So in this example the interest rate differential is in our favor by 1.75%, so we will earn interest if we hold this position past 5pm NY Time.

If we were to sell the
USD/JPY then we are short (borrowing) US Dollars at an interest rate of 2.25% and long (holding) JPY at an interest rate of .5%. So in this case the interest rate differential is against us by 1.75% so we will pay interest if we hold this position past 5pm NY Time.

I have tried to make this as simple as possible but to be upfront this is probably the most difficult concept for traders who are new to the
forex

Thats our lesson for today. In tomorrow's lesson we are going to continue our rollover discussion with a look at where you go to find out whether you are going to pay or receive money for holding positions past rollover and the basics of how traders leverage this rollover concept to their advantage so we hope to see you in that lesson.

As always if you have any questions or comments please leave them in the comments section below, and good luck with your trading!
market to grasp, so if it takes a little bit of time don't worry you are not alone. If you have questions I am sure that others have similar ones so please be sure to post them in the comments section below so we can all learn together.

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Old 10-12-2008, 09:38 AM   #2 (permalink)
 
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How to rollover works


Hi David,
Are you saying that if I open and close a position (or complete a trade) before 5pm est then I will not earn/pay interest on my gains? But my gains I will receive?

Sanny
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Old 10-13-2008, 08:14 AM   #3 (permalink)
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Hi Sanny,

Glad to hear from you and welcome to the community.

Yes that is correct.

Best Regards,
Dave
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Old 10-28-2008, 12:35 PM   #4 (permalink)
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How Rollover Works in the Forex Market


Hi David, thanks for the videos, i'm learning very fast
The interest rate is 2.25% anual this is a very small amount of money, why is this so important ?
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Old 10-28-2008, 12:52 PM   #5 (permalink)
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Hi christopherrosep,

Glad to hear from you and welcome to the community.

You are correct that this is a fairly small amount of interest but remember that in some countries, like Australia and New Zealand where interest rates are 6% or higher this can make a fairly big difference. This is especially true when trading these currencies against a currency like the Japanese Yen which has an interest rate of .5%.

When you add to this the fact that you have access to a large amount of leverage in the forex market, and you can take that 5% return or so, leverage it 3 or 4 times and turn it into a 15 or 20% return.

Hope that helps. If there are any other questions or comments please feel free to post as always.

Best Regards,
Dave
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Old 12-14-2008, 02:36 PM   #6 (permalink)
 
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maybe I'm asking this question too early (before listening to other lessons), but ... since interest rates are fixed (at least in the short/mid term), does your calculation, Dave, of 15-20% return implies that the profit without any risk? I'm sure I missunderstood something here ...
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Old 12-14-2008, 07:45 PM   #7 (permalink)
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Hi Sule4,

No worries feel free to ask questions as you go along even if you feel they may be answered later as that is in my opinion the best way to learn.

The risk here is that the price of the currency pair that you are trading to earn the carry will move against you, offsetting the gain or causing greater losses than what you earn in interest.

Best Regards,
Dave
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Old 12-29-2008, 05:42 AM   #8 (permalink)
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Hi David,

I really appreciate your videos. Very clear, informative, and easy to understand.

Here's my question which I haven't been able to figure out for a while.

In the Trade Station, why are negative Rollovers always greater than the positive ones?
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Old 12-29-2008, 10:21 AM   #9 (permalink)
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Hi Sammy,

Thanks for the compliment and good question.

You can think of rollover when you are long the currency pair with the higher interest rate in a similar way as you would when you earn interest by depositing money at a bank. Because you are long the currency with the higher interest rate you earn interest.

Conversely you can think of rollover when you are short the currency with the higher interest rate in a similar way as you would when you pay interest by borrowing money at a bank. Because you are short the currency with the higher interest rate you pay interest.

So just like when you deposit money at a bank you earn less interest than you pay when you borrow money from a bank, when you are long the currency with the higher interest rate you earn less interest than when you are short the currency with the higher interest rate.

Let me know if that does not make sense or if you have any other questions.

Best Regards,
Dave
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Old 01-07-2009, 07:01 PM   #10 (permalink)
 
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hi david, just wanted to say thanks for putting all of this info online for free. It's great for a person like me just starting out to understand how things work before I start spending money. so THANKS!

a few questions about rollovers. Is it always 5pm EST that the rollover is effected? ..or does it depend on the pair I am trading? ..or my broker?

Also, you mention that a rollover is 2 days of interest. Is this because there are 2 currencies in play? So the rollover goes into effect after only one day? ...or two? what if I make a trade at 4:59pm?

thanks again, this stuff is like gold to me.
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