Taking Rollover Into Account in Forex Trading

05/05/2010 12:01 am EST

Focus: FOREX

In this lesson we are going cover rollover. We will start by explaining the concept of rollover and then go into an example of how it is calculated. We will show you how to take advantage of rollover because many successful traders make it an integral part of their trading strategy.

Rollover is the interest paid or earned for holding a position overnight. The target interest rate associated with each currency (generally set by that currency’s central bank) is listed on the home page of DailyFX.com. Here is an example (NOTE: All prices and interest rates shown in this article are for instructional purposes only and are not currently accurate):

Anytime you take an FX position, you are buying one currency and selling the other. Your position will therefore earn the interest rate of the currency that you have bought, and you will owe the interest rate of the currency that you sold. The net difference will either be credited to your account or debited from your account every day at rollover, which is 5 pm ET US. It’s important to note that rollover only occurs on positions that are held open at 5 pm ET.  If you close a trade before the rollover time, or open it after the rollover time, no interest will be paid or owed.

We’ll go through an example in a bit, but to make things simple, the amount of rollover that is paid or earned for each pair can be seen in the dealing rates window of the trading station below. “RollS” is the amount you will earn or owe for each lot if you have sold the pair. “RollB” is the amount that you will earn or owe for each lot if you have bought the pair.

Let's take a look at an example:


When you buy the AUD/USD pair, you are buying the Australian dollar and selling the US dollar.

Here is the math:

In this example, we are buying one 10k lot of AUD/USD in a US dollar-based account. So we are going to earn 3% annually on 10,000 AUD. This comes out to 300 AUD per year.  To determine one day’s worth of rollover, we’ll divide by 365, which gives us 0.82 AUD in interest per day.

On the other side of the trade, we are short approximately $8,800 USD (the AUD/USD rate is 0.8780 at the time of writing). For this side of the trade, we owe 0.25% on the US dollars that we are short. So 8,800 x 0.0025 = $22 US. Divide that by 365, and you get $0.06.  

Now we know that if we buy one 10k lot of AUD/USD, we’ll earn 0.82 AUD and owe $0.06 USD. To net these two together, we’ll first convert the 0.82 AUD to USD dollars. To do that we simply multiply by 0.8780 (the current AUD/USD spot rate), which gets us to $0.72 US.

$0.72 - $0.06 = $0.66. So, according to our math, we should earn about $0.66 US per day for buying one 10k lot of AUD/USD.

We can see here that it shows 0.49 for RollB. Why doesn’t it match?  The reason is that the interest rates that we used in our example—3% for the AUD and 0.25% for the USD—are simply the target rates set by the central banks of those countries. Market participants (i.e. banks) will determine where the actual overnight lending and deposit rates should be. So, unfortunately, our calculation and this example here is just to help understand rollover conceptually. Doing the calculation based on target rates will never get you to the exact rollover value that is charged or earned, but it is a good exercise to understand how rollover works.

The next question that many traders ask is “Why do we get charged more then we can earn on rollover?” You can see here again that if we’re long AUD/USD, we’ll earn $0.49, but if we are short, we will owe $1.07. The answer is that banks introduce a spread on the interest rates. They will pay us a bit less than the overnight rate when we lend to them, and they will charge us a bit more then than the overnight rate we you borrow from them. The end result is that, unfortunately, we traders always get charged more then we earn when it comes to rollover (This is also why RollS and RollB can both be negative at times).

That doesn’t negate the powerful impact that rollover can have on a trading strategy. Some traders will only go into positions that will allow them to earn at rollover.

Let’s go to the simple dealing rates view and see what currency pair pays us the most for rollover.


Simple Dealing Rates:

Click to Enlarge

We can see here that going short one 10k lot of GBP/AUD pays us $0.81 a day in rollover. That may not sound like a lot, but it works out to $295.65 of interest per year that we will earn. And that interest is earned even if the pair doesn’t move a single pip. Also, considering that we may have only had to post around 1% or less in margin to hold that trade, $295 is a significant percentage return. Holding a position long term to collect the interest rate differential is referred to as a “carry trade” and is one of the most popular strategies in the market.

Now we have to keep in mind that a carry trade certainly isn’t risk free. The spot rate itself will of course fluctuate, and that can work for or against us. Also, interest rates often change, and the amount that you earn or owe each day will therefore change as well. So if you are going to be a carry trader, be sure to stay on top of interest rate movements and sentiment.

An important thing to note is Wednesday rollover. This can be a bit confusing, so don’t worry if you don’t get it right away.

FX is generally a two-day deliverable market. That means that positions will settle two days from when they are opened.  Wednesday at 5pm, positions get rolled over to Thursday positions. These positions would technically settle on Saturday, but banks are closed on Saturdays, so instead, they are rolled through the weekend to Monday. So the short of it is that Wednesday rollover is typically three days worth of interest. There is no rollover applied to positions that are held open on Saturdays and Sundays. Holidays can also affect the rollover schedule. You can easily reference the special holidays and how they affect rollover on our regularly updated rollover calendar.

So would the ZAR would be a good carry trade as the interest rates there are a lot higher than the USA? And what do traders have to do to earn interest when trading the USD/ZAR?

Regardless of the pair being traded, as long as a trader is buying the currency in the pair with the higher interest rate, they will earn the interest differential on the pair.

Currently, if the USD/ZAR pair is shorted, meaning you are selling the USD and buying the ZAR, interest would be earned since the ZAR has a higher rate than the USD. Conversely, if the trader buys the pair, they would then pay interest since they are long the currency with the lower interest rate, the USD, and short the currency in the pair with the higher interest rate, the ZAR.

So that covers rollover and how it is calculated. Hopefully you now understand a bit about how to take advantage of it as well.

By the Staff at DailyFX.com

DailyFX provides forex news on the economic reports and political events that influence the currency market.

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