In forex trading, rollover is a process that happens behind the curtain when traders hold their positions overnight. This process extends the settlement date of a trade, which usually occurs two business days after the transaction. Understanding rollover can help traders manage their positions more effectively and make informed decisions about their trading strategies. But that’s not all because rollover can also be a potential source of profits. One such rollover strategy in forex trading is the carry trade, which we discussed in detail in a previous post. We’ll explore a dishonest twist on this strategy in today’s post. So, buckle up, and let’s dive in.
What is Rollover in Forex?
Before diving into any rollover strategies in forex trading, let us define this process first so that we are all on the same page. In forex trading, “rollover” happens when you keep a position open overnight. Forex trades usually settle two business days after you make them, but if you’re holding onto a trade for longer, you’ll need to roll it over to extend the settlement date.
When you roll over a position, you either pay or earn interest based on the interest rate difference between the two currencies in your trade. This is called the “swap rate.” You’ll gain some interest if you hold a currency with a higher interest rate than the one you’re selling. But if it’s the reverse, you’ll have to pay interest.
Brokers usually handle rollovers automatically at the end of the trading day, around 5 PM New York time. The amount you pay or receive depends on the size of your position, the interest rate difference, and your broker’s specific rules.
What Happens Behind the Scenes During the Rollover Procedure?
There’s a potential opportunity to earn a bit extra during the transition between trading days—a process known as rollover. Brokers and banks initiate various procedures during this time, which can widen spreads. Let’s examine an example to understand this better.
Dealing departments in banks often open multiple trades within a single day. Not all these positions are closed by the end of the trading day. Specific procedures require closing and reopening trades to carry a position to the next trading day. Since spreads in the interbank market are usually quite tight, the losses incurred from the spread when reopening trades are not significant, but they do exist. These losses affect both short and long positions.
Due to the potentially sizeable total position, the available volumes are swept up across the entire order book during the rollover procedure. This can cause relatively short-term price movements: ask prices might increase while bid prices might decrease. After closing, the opposite procedure occurs—reopening the closed trading volumes, leading to price movements in the order book.
Not all brokers, dealers, and banks reopen orders at exactly midnight. This process takes about half an hour and varies depending on how each entity has set it up to avoid overloading their servers with all the operations at once. Incidentally, this is also one of the reasons for the widening spread.
For brokers who get their price feeds from prime brokers and banks, transitioning through the end of the day is different. There’s no closing and reopening of orders per se. Your broker will “roll” your position over at the end of each trading day if you don’t close it. For this, they will apply a swap fee to your open positions.
FUN FACT: That is why professionals sometimes use the term “rolling forex contracts” to describe the financial product that retail traders trade. By the way, it is the same as CFDs. It reflects the continuous, day-to-day renewal process of forex trading positions, making it convenient for traders to maintain positions without worrying about expiry dates.
Most retail brokers describe swaps as a fee for carrying a position over to the next trading day, claiming it’s based on interest rates. However, in reality, it’s not quite that simple. We’ll discuss the various ways these swaps can be calculated in future articles, but for now, let’s talk about how some traders used to profit from this in the past.
Now that we understand what happens behind the scenes, we can finally look at the rollover strategies in forex trading.
Carry Trade with a Dishonest Twist
As part of ongoing efforts to expand and attract new clients, many retail Forex brokers were trying to find a way to work with clients from Islamic countries. However, due to religious restrictions, forex brokers couldn’t attract clients from these regions using their standard accounts.
That’s where so-called “Islamic accounts” came into play. The main distinguishing feature of these accounts is the absence of swaps. Brokers introduced these additional types of accounts alongside their standard ones. Forex brokers don’t charge swap fees in Islamic accounts in short or long trades.
Brokers started offering Islamic accounts in the early 2000s. This initiative was driven by the need to accommodate Muslim traders. They are bound by Sharia law, which prohibits earning interest on financial transactions.
The introduction of Islamic accounts, also known as swap-free accounts, allowed brokers to tap into the growing market of traders from Islamic countries. This move expanded brokers’ client base and provided Muslim traders with access to the Forex market in a Sharia-compliant manner.
This immediately led to a surge of traders claiming to be devout Muslims who urgently needed such accounts. While some may indeed have been religious individuals, a significant portion was attempting a scam involving swaps.
Looking at this table of different brokers, you’ll likely notice that swaps are positive in one direction and negative in the other. The size of the swap is larger for exotic currency pairs. This presented an opportunity for profit. Let us explain how.
To exploit this, one needs to open two accounts with different brokers. As you might have guessed, one of these accounts would be an “Islamic account.”
The scheme worked as follows: on a regular account, a trader would open a trade that accrued a positive swap. On the Islamic account, that trader would open a trade in the same currency pair but in the opposite direction.
Everything makes more sense with an example, so let’s introduce one. Let’s say our trader goes short on USD/MXN in their regular account. Then, this trader goes long for the same pair in an Islamic account with a different broker. It makes more sense now, doesn’t it?
Since the broker doesn’t charge the swap fee on the Islamic account, our trader creates a synthetically “locked position.” In forex trading, a “locked position” refers to a situation where a trader holds both a long (buy) and a short (sell) position on the same currency pair simultaneously.
Some people also refer to it as “hedging.” As long as the locked position remains in place, one position can potentially offset the losses of the other. And let us not forget that one of the positions is accumulating a positive swap fee.
This “strategy” generated riskless profits, which could be substantial, especially with the trader’s use of high leverage. Once brokers realized what was happening, they adjusted their trading conditions slightly, rendering this strategy obsolete. However, you might still find brokers who allow you to execute such a scheme.
As you can see, this variety of rollover strategies in forex trading involves dishonest practices on the part of the trader, not the forex broker. If we remove the dishonest part from it, it becomes a classic carry trade based on actual science and research in the field of macroeconomy.
We’ll discuss other ways to earn from rollovers in future posts.
We strongly condemn such practices that exploit the system for unfair gain. At our core, we believe in maintaining a level playing field and ensuring fair trading conditions for all market participants. It’s essential for the integrity of the Forex market that all traders adhere to ethical standards and engage in honest trading practices.
DISCLAIMER! The contracts for difference (CFDs) we discuss come with high risks, and you could lose all the money you put in. Make sure you understand all the risks involved before you dive in.
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