Educational: Unlocking passive income through swaps/rollover
In this publication, we will go into a strategy for generating passive income within the forex market, irrespective of market direction. While traditional trading methods often rely on correctly predicting market directions, what if there was a way to earn without speculating on market movements? Surprisingly, such an avenue exists, and it involves capitalizing on daily swap/rollover fees through leveraging negative correlation between currency pairs.
đź”·What are swaps?
In the forex market, a swap, also known as a rollover or overnight interest, refers to the interest rate differential between two currencies that are part of a currency pair. When you trade forex, you are essentially borrowing one currency to buy another. Each currency in a pair has an associated interest rate set by the central bank of its respective country.
Current interest rates.
How a forex trade works.
Swaps are incurred when a forex position is held overnight or over the weekend. Since forex trading operates 24 hours a day, except on weekends, trades held beyond the daily cutoff time (usually around 5 p.m. EST) are subject to swaps.
When you open a forex trade, you are simultaneously buying one currency and selling another. Each currency has its own interest rate. If the interest rate on the currency you are buying is higher than the interest rate on the currency you are selling, you will earn a positive swap. Conversely, if the interest rate on the currency you are selling is higher than the interest rate on the currency you are buying, you will incur a negative swap.
Swaps are calculated based on the notional value of the trade, which is the size of the position you are trading. The notional value is multiplied by the swap rate, which is the interest rate differential, and then adjusted for any applicable broker fees or commissions. The resulting amount is either added or subtracted from your trading account at the end of the trading day.
It's important to note that swaps are not always interest rate differentials. In some cases, they may also include other costs such as administrative fees or adjustments related to market conditions.
đź”·How to know if your trade has positive or negative swap.
You can find this out before executing a trade in the platform you are using to execute the trade. One of the most popular platforms in the forex retail industry is MT4 and MT5 (MetaTrader 4/5) I will show you to to locate the rates in these platforms but note that this data is available regardless of the trading platform. If you are not sure how to find this in your platform simply reach out to your broker.
1: Open your MetaTrader 4/5 platform and open your market watchlist
2: Right click on the the pair you are interested in and go to "specifications"
3: An additional window should now open showing additional information on the pair. Scroll all the way down and you will find swap details. Now here you can see Swap Long and Swap Short indicating if you open a buy or sell position, if you will earn positive swap or negative swaps
Now at this point you are probably saying "Okay fine, but even if I am earning a positive swap for holding a short position on
EURUSD
if the trade goes against me I will lose a lot more than I will earn" And that is true. So now for the other part of earning passively without worrying about the trade direction.
đź”·Correlation in the forex market
Correlation in the forex market refers to the statistical relationship between the price movements of two or more currency pairs. It measures the degree to which the pairs move in relation to each other.
Positive correlation: A positive correlation means that two currency pairs tend to move in the same direction
Positive correlation: A positive correlation means that two currency pairs tend to move in the same direction
Zero correlation: A correlation coefficient of zero (0) indicates no significant relationship between the currency pairs. In this case, the price movements of the pairs are independent of each other.
Correlation can be measured over different time periods, such as daily, weekly, or monthly. Short-term correlations may differ from long-term correlations due to changing market conditions and events. For our purposes we care about daily and above correlation.
đź”·How to check correlation of pairs
Out of respect for TradingView and their house rules I will not recommend any specific websites in order to check correlation of pairs but there are a number of websites out there that will advise on the negative or positive correlation of pairs in relation to others. There are also scripts here on TradingView that will do that calculation for you. Below is a image of pairs and there current correlation. BUT DO NOTE THAT CORRELATION CHANGES OVERTIME AS MARKET CONDITIONS SHIFT AND YOU SHOULD CHECK CORRELATIONS DAILY OR WEEKLY
The image above gives an idea as to how these correlation charts will look, where a higher percentage indicates strong correlation and lower indicating weak correlation.
đź”·Setting up passive earning via swaps
Currently, our focus lies on identifying a currency pair exhibiting a positive swap and a negative correlation with another currency pair that also possesses a positive swap. This holds particular significance in our analysis. Alternatively, we can seek a currency pair with a positive swap alongside a currency pair with a negative swap, provided that the positive swap surpasses the negative swap.
Here is an example.
NZDJPY
has a positive swap if we are to open a buy position.
So what we need is a pair that is negatively correlated to
NZDJPY
but has a positive swap on shorts or a lower negative swaps on the shorts
Lets look at pairs negatively correlated with
NZDJPY
We can check the correlation based on different timeframes. Remember that the more a pair is negatively correlated, the better for our strategy. For demonstration purposes we will use the daily timeframe. In this case it's
EURNZD
with a 71.6% negative correlation. Note the daily timeframe for
EURCZK
has a higher negative correlation of 82.7% which would be better for our strategy. ( We are not using that pair only because my broker does not offer that pairs for trading)
We can also see that
EURNZD
has a positive swap for shorts
:
Okay so the next thing we need to look at is the negative correlation historically overtime to see how long the pairs have remain negatively correlated in the past.
In the depicted images, we observe that the daily timeframe predominantly exhibits a negative correlation over the course of the year, with a brief period of positive correlation occurring in March and May. Conversely, the weekly timeframe has consistently demonstrated a negative correlation since 2021.
Before proceeding with our trades, I highly recommend referencing the charts of both currency pairs to visually assess their correlation on the mentioned timeframes. This will provide you with a clearer understanding of what to anticipate. Please find the illustration below showcasing the correlation between the pairs on the specified timeframes.
So as you can see in the images above the correlation is not 1-1 in terms of price movements but in general the pairs move opposite to each other and this is what we want.
Now what you need to do is simply execute your trades based on your preferred risk profile. The larger your position is on both pairs the more your will earn daily via swaps, you need to execute using the same size lot size on both pairs. For our example you would execute a buy on
NZDJPY
and a sell on
EURNZD
This approach presents a method of generating passive income without relying on predicting future price movements or attempting to outperform the markets. While there may be periods when your account balance shows a negative value, the concept behind this strategy lies in the negative correlation between the selected currency pairs. Over time, these pairs are expected to offset losses on either side, resulting in minimal overall gains or losses, assuming the negative correlation remains intact.
To ensure the ongoing viability of this strategy, it is crucial to regularly monitor the correlation between the pairs on a weekly basis. When the correlation approaches zero, caution is advised. Monitoring market fundamentals, particularly interest rates, is essential as they greatly influence the correlation between markets.
Through the accumulation of swap profits over time, the goal is for the total profits from swaps to outweigh the overall risk involved in maintaining these positions.
It's important to note that while this approach emphasizes a more passive trading style, it still requires active monitoring and attention to market conditions to ensure the expected correlation and swap profits are maintained.
Positives of this investment strategy:
🔸Passive Income: By trading swaps and holding positions over time, you can potentially earn passive income through positive swap rates. This income adds to your overall trading profits without requiring active trading or predicting price movements.
🔸Diversification: Trading swaps allows you to diversify your trading portfolio and reduce risk. By selecting currency pairs with different interest rates and correlation patterns, you can offset potential losses in one position with gains from another.
🔸Potential Long-Term Profits: Over time, as swap profits accumulate, they can contribute to your overall trading profits. This can be particularly beneficial for traders with a long-term investment horizon.
🔸Reduced Focus on Short-Term Price Movements: Trading swaps shifts the focus away from constantly monitoring short-term price fluctuations. Instead, you can concentrate on macroeconomic factors, interest rate differentials, and correlation patterns that affect the swaps and overall profitability.
Negatives:
🔸Market Risk: Although trading swaps can provide passive income, it does not eliminate market risk. Currency prices can still experience significant volatility, economic events can impact interest rates and correlations, and unexpected market developments can affect swap rates and profitability.
🔸Swap Rates Fluctuations: Swap rates are subject to change based on various factors, including central bank decisions, economic data releases, and market conditions. Fluctuations in swap rates can affect your expected income and overall profitability.
🔸Potential Losses: Although the aim is to minimize losses through negative correlation, there may still be occasions when both positions experience losses simultaneously. Negative correlation does not guarantee complete protection against losses, particularly during periods of high market volatility or unexpected events.
🔸Monitoring and Administration: Trading swaps requires ongoing monitoring of correlation patterns, interest rates, and swap rates. It also involves administrative tasks, such as calculating and tracking swap income and adjusting positions as necessary.
It is important to thoroughly understand the risks and benefits of trading swaps and earning over time before implementing this strategy. Consider your risk tolerance, trading goals, and the suitability of this approach within your overall trading strategy. THIS IS NOT INVESTMENT ADVISE.
đź”·What are swaps?
In the forex market, a swap, also known as a rollover or overnight interest, refers to the interest rate differential between two currencies that are part of a currency pair. When you trade forex, you are essentially borrowing one currency to buy another. Each currency in a pair has an associated interest rate set by the central bank of its respective country.
Current interest rates.
How a forex trade works.
Swaps are incurred when a forex position is held overnight or over the weekend. Since forex trading operates 24 hours a day, except on weekends, trades held beyond the daily cutoff time (usually around 5 p.m. EST) are subject to swaps.
When you open a forex trade, you are simultaneously buying one currency and selling another. Each currency has its own interest rate. If the interest rate on the currency you are buying is higher than the interest rate on the currency you are selling, you will earn a positive swap. Conversely, if the interest rate on the currency you are selling is higher than the interest rate on the currency you are buying, you will incur a negative swap.
Swaps are calculated based on the notional value of the trade, which is the size of the position you are trading. The notional value is multiplied by the swap rate, which is the interest rate differential, and then adjusted for any applicable broker fees or commissions. The resulting amount is either added or subtracted from your trading account at the end of the trading day.
It's important to note that swaps are not always interest rate differentials. In some cases, they may also include other costs such as administrative fees or adjustments related to market conditions.
đź”·How to know if your trade has positive or negative swap.
You can find this out before executing a trade in the platform you are using to execute the trade. One of the most popular platforms in the forex retail industry is MT4 and MT5 (MetaTrader 4/5) I will show you to to locate the rates in these platforms but note that this data is available regardless of the trading platform. If you are not sure how to find this in your platform simply reach out to your broker.
1: Open your MetaTrader 4/5 platform and open your market watchlist
2: Right click on the the pair you are interested in and go to "specifications"
3: An additional window should now open showing additional information on the pair. Scroll all the way down and you will find swap details. Now here you can see Swap Long and Swap Short indicating if you open a buy or sell position, if you will earn positive swap or negative swaps
Now at this point you are probably saying "Okay fine, but even if I am earning a positive swap for holding a short position on
EURUSD
if the trade goes against me I will lose a lot more than I will earn" And that is true. So now for the other part of earning passively without worrying about the trade direction. đź”·Correlation in the forex market
Correlation in the forex market refers to the statistical relationship between the price movements of two or more currency pairs. It measures the degree to which the pairs move in relation to each other.
Positive correlation: A positive correlation means that two currency pairs tend to move in the same direction
Positive correlation: A positive correlation means that two currency pairs tend to move in the same direction
Zero correlation: A correlation coefficient of zero (0) indicates no significant relationship between the currency pairs. In this case, the price movements of the pairs are independent of each other.
Correlation can be measured over different time periods, such as daily, weekly, or monthly. Short-term correlations may differ from long-term correlations due to changing market conditions and events. For our purposes we care about daily and above correlation.
đź”·How to check correlation of pairs
Out of respect for TradingView and their house rules I will not recommend any specific websites in order to check correlation of pairs but there are a number of websites out there that will advise on the negative or positive correlation of pairs in relation to others. There are also scripts here on TradingView that will do that calculation for you. Below is a image of pairs and there current correlation. BUT DO NOTE THAT CORRELATION CHANGES OVERTIME AS MARKET CONDITIONS SHIFT AND YOU SHOULD CHECK CORRELATIONS DAILY OR WEEKLY
The image above gives an idea as to how these correlation charts will look, where a higher percentage indicates strong correlation and lower indicating weak correlation.
đź”·Setting up passive earning via swaps
Currently, our focus lies on identifying a currency pair exhibiting a positive swap and a negative correlation with another currency pair that also possesses a positive swap. This holds particular significance in our analysis. Alternatively, we can seek a currency pair with a positive swap alongside a currency pair with a negative swap, provided that the positive swap surpasses the negative swap.
Here is an example.
NZDJPY
has a positive swap if we are to open a buy position.
So what we need is a pair that is negatively correlated to
NZDJPY
but has a positive swap on shorts or a lower negative swaps on the shorts Lets look at pairs negatively correlated with
NZDJPY
EURNZD
with a 71.6% negative correlation. Note the daily timeframe for
EURCZK
has a higher negative correlation of 82.7% which would be better for our strategy. ( We are not using that pair only because my broker does not offer that pairs for trading) We can also see that
EURNZD
has a positive swap for shorts
Okay so the next thing we need to look at is the negative correlation historically overtime to see how long the pairs have remain negatively correlated in the past.
In the depicted images, we observe that the daily timeframe predominantly exhibits a negative correlation over the course of the year, with a brief period of positive correlation occurring in March and May. Conversely, the weekly timeframe has consistently demonstrated a negative correlation since 2021.
Before proceeding with our trades, I highly recommend referencing the charts of both currency pairs to visually assess their correlation on the mentioned timeframes. This will provide you with a clearer understanding of what to anticipate. Please find the illustration below showcasing the correlation between the pairs on the specified timeframes.
Now what you need to do is simply execute your trades based on your preferred risk profile. The larger your position is on both pairs the more your will earn daily via swaps, you need to execute using the same size lot size on both pairs. For our example you would execute a buy on
NZDJPY
and a sell on
EURNZD
This approach presents a method of generating passive income without relying on predicting future price movements or attempting to outperform the markets. While there may be periods when your account balance shows a negative value, the concept behind this strategy lies in the negative correlation between the selected currency pairs. Over time, these pairs are expected to offset losses on either side, resulting in minimal overall gains or losses, assuming the negative correlation remains intact.
To ensure the ongoing viability of this strategy, it is crucial to regularly monitor the correlation between the pairs on a weekly basis. When the correlation approaches zero, caution is advised. Monitoring market fundamentals, particularly interest rates, is essential as they greatly influence the correlation between markets.
Through the accumulation of swap profits over time, the goal is for the total profits from swaps to outweigh the overall risk involved in maintaining these positions.
It's important to note that while this approach emphasizes a more passive trading style, it still requires active monitoring and attention to market conditions to ensure the expected correlation and swap profits are maintained.
Positives of this investment strategy:
🔸Passive Income: By trading swaps and holding positions over time, you can potentially earn passive income through positive swap rates. This income adds to your overall trading profits without requiring active trading or predicting price movements.
🔸Diversification: Trading swaps allows you to diversify your trading portfolio and reduce risk. By selecting currency pairs with different interest rates and correlation patterns, you can offset potential losses in one position with gains from another.
🔸Potential Long-Term Profits: Over time, as swap profits accumulate, they can contribute to your overall trading profits. This can be particularly beneficial for traders with a long-term investment horizon.
🔸Reduced Focus on Short-Term Price Movements: Trading swaps shifts the focus away from constantly monitoring short-term price fluctuations. Instead, you can concentrate on macroeconomic factors, interest rate differentials, and correlation patterns that affect the swaps and overall profitability.
Negatives:
🔸Market Risk: Although trading swaps can provide passive income, it does not eliminate market risk. Currency prices can still experience significant volatility, economic events can impact interest rates and correlations, and unexpected market developments can affect swap rates and profitability.
🔸Swap Rates Fluctuations: Swap rates are subject to change based on various factors, including central bank decisions, economic data releases, and market conditions. Fluctuations in swap rates can affect your expected income and overall profitability.
🔸Potential Losses: Although the aim is to minimize losses through negative correlation, there may still be occasions when both positions experience losses simultaneously. Negative correlation does not guarantee complete protection against losses, particularly during periods of high market volatility or unexpected events.
🔸Monitoring and Administration: Trading swaps requires ongoing monitoring of correlation patterns, interest rates, and swap rates. It also involves administrative tasks, such as calculating and tracking swap income and adjusting positions as necessary.
It is important to thoroughly understand the risks and benefits of trading swaps and earning over time before implementing this strategy. Consider your risk tolerance, trading goals, and the suitability of this approach within your overall trading strategy. THIS IS NOT INVESTMENT ADVISE.
Comment:
I have a new publication that speaks on the correlation between pairs in your watchlist. This can help here when creating your watchlist to know what pairs to hedge against. Note that this new publication speaks on stops loss and take profits. Earning via swaps does not necessarily require a stop loss or take profit.
C Nicholas Downie
Script by :@LeviathanCapital