Even though the mighty US dominates many markets, most of Spot
Forex is still traded through London in Great Britain. So for our next
description we shall use London time. Most deals in Forex are done
as Spot deals. Spot deals are nearly always due for settlement two
business days later. This is referred to as the value date or delivery
date. On that date the counter parties theoretically take delivery of the
currency they have sold or bought.
In Spot FX the majority of the time the end of the business day is
21:59 (London time). Any positions still open at this time are
automatically rolled over to the next business day, which again
finishes at 21:59.
This is necessary to avoid the actual delivery of the currency. As Spot
FX is predominantly speculative, most of the time the traders never
wish to actually take delivery of the currency. They will instruct the
brokerage to always rollover their position.
Many of the brokers nowadays do this automatically and it will be in
their policies and procedures. The act of rolling the currency pair over
is known as tom.next, which stands for tomorrow and the next day.
Just to go over this again, your broker will automatically rollover your
position unless you instruct him that you actually want delivery of the
currency. Another point worth noting is that most leveraged accounts
are unable to actually deliver the currency as there will be insufficient
capital there to cover the transaction.
Remember that if you are trading on margin, you have in effect used
a loan from your broker for the amount you are trading. If you had a 1
lot position your broker will have advanced you the $100,000 even
though you did not actually have $100,000. The broker will normally
charge you the interest differential between the two currencies if you
rollover your position. This normally only happens if you have rolled
over the position and not if you open and close the position within the
same business day.
To calculate the broker's interest he will normally close your position
at the end of the business day and again reopen a new position
almost simultaneously. You open a 1 lot ($100,000) EUR/USD
position on Monday 15th at 11:00 at an exchange rate of 0.9950.
During the day the rate fluctuates and at 22:00 the rate is 0.9975. The
broker closes your position and reopens a new position with a
different value date. The new position was opened at 0.9976 - a 1 pip
difference. The 1 pip difference reflects the difference in interest rates
between the US Dollar and the Euro.
In our example you are long Euro and short US Dollar. As the US
Dollar in the example has a higher interest rate than the Euro you pay
the premium of 1 pip.
Now the good news - If you had the reverse position and you were
short Euros and long US Dollars you would gain the interest
differential of 1 pip. If the first named currency has an overnight
interest rate lower than the second currency, then you will pay that
interest differential if you bought that currency. If the first named
currency has a higher interest rate than the second currency, then
you will gain the interest differential.
To simplify the above - If you are long (bought) a particular currency
and that currency has a higher overnight interest rate, you will gain. If
you are short (sold), the currency with a higher overnight interest rate,
then you will lose the difference.
I would like to emphasize here that although we are going a little indepth to explain how all this works, your broker will calculate all of
this for you. The purpose of this book is just to give you an overview
of how the forex market works.
