Rollovers, Interest Rate Differentials, and Value Dates

Forex traders make money trading currency, either buying low then selling high, or selling high then buying low. Profits and losses are determined by the relative purchase and sale prices in opening and closing positions. However, profits and losses will also be affected by the different interest rates of the currency pair, by when the trades actually settle, and how long the position is held.

Whenever you have an open position in forex trading, you are exchanging 1 currency for another. This is true whether you open a long or short position in a specific currency. If you are long in 1 currency, then you are short in the other. For instance, if you buy British pounds (GBP) with U.S. dollars (USD), then you are exchanging USD for GBP, which is the same as selling USD short for GBP. Buying GBP/USD is the same as selling short USD/GBP.

If you have no open currency position, then you are said to be flat or square. Sometimes closing a position is termed squaring up.

Value Dates

The day that a currency is traded is known as the trade date, or entry date. This is the date when your order for a trade was entered and accepted by your broker. Then the trade is settled sometime later, when the transaction is actually completed. The date of settlement is known as the value date (aka settlement date, delivery date).

Because settlement takes time, especially between continents with different time zones, most currency trades settle in 2 good business days, which is often depicted as T+2. The exception is North American currency pairs, such as those pairs consisting of the United States dollar, the Canadian dollar (CAD), or the Mexican peso (MXN), which settle in 1 good business day (T+1). So, for instance, USD/CAD would settle in 1 good business day, while USD/EUR would settle in 2 good business days.

For an FX forward contract, the value date is the contract maturity date + 1 day for North American currency pairs or 2 days for other pairs.

A good business day is a day that is not a holiday or weekend in either currency country. Because different countries have different holidays, this can sometimes lead to a value date that is 6 or 7 days from the trade date, particularly at the beginning and end of the year.

Because currency trading is a 24-hour, global market, there needs to be an agreement as to what constitutes the end of the day. By convention, settlement time on the value date is at that time that corresponds to 5 P.M. Eastern Standard Time (EST). After the settlement time, the trade day advances, so the trade day for a trade after 5 P.M. EST on Monday is considered Tuesday. So a trade in EUR/USD on 3 P.M. Monday Eastern time would settle on Wednesday at 5 P.M. However, if the same currency pair was traded at 6 P.M. on Monday, then the trade day would be Tuesday and the value date would be Thursday at 5 P.M. EST. A T+2 currency pair that was traded after 5 P.M. on Wednesday would settle on Monday, assuming Thursday, Friday, and Monday are good business days.

Rollovers and Interest Rate Differentials

In the spot market, the settlement of a currency trade usually requires the delivery and acceptance of the currency. However, most forex traders do not trade currency intending to take or make delivery of the currency — they trade for profits from speculation. Hence, most brokers who cater to the speculators automatically roll over the contracts from 1 value date to the next on each good business day until the trader closes the transaction — a process called, naturally enough, a rollover. Rollovers, in effect, continually delays the actual settlement of the trade until the trader closes her position.

On an open position, interest is earned on the long currency and paid on the short currency every time the position is rolled over. The interest that is earned or paid is usually the target interest rate set by the central bank of the country that issued the currency. When the interest rates of the 2 countries are different, then there is an interest rate differential which will result in a net earning or payment of interest. If the interest rate associated with the base currency is higher than the quote currency, then the trader earns the interest differential; otherwise, the trader must pay the interest differential. This net interest is often called the rollover rate and is calculated and either added or deducted from the trader's account at the rollover time of each trading day that the position is open. Whether it is added or deducted depends on whether the rollover rate is positive or negative — hence, when it is added it is called a positive rollover (aka positive roll) and a negative rollover (aka negative roll) is subtracted. This interest is added or deducted every day that the position is rolled over — a one-day rollover.

However, interest is calculated for every day that the position is held, including weekends and holidays, so the amount of interest credited or debited depends on the number of days between rollovers. So a weekend rollover, which is any T+2 trade that takes place after the settlement time on Wednesday (or Thursday for a T+1 currency pair), will involve 3 times as much interest as a one-day rollover because there are 3 days instead of just 1 day between rollovers. If the rollover period is extended because of holidays, then the additional holidays are counted as well. Hence, any currency pair traded after the settlement time on Wednesday (for a T+2 pair) or Thursday (for a T+1 pair) will have a 3-day rollover, and will pay or cost 3 times as much in interest as a 1-day rollover.

Forex brokers also charge some interest, so the exact amount of interest that you will earn or pay will depend on the broker. If you have a large amount in your account, you may be able to negotiate a smaller interest rate spread. Virtually all trading platforms make the appropriate interest adjustments to your account automatically, so you do not have to calculate the interest. Some brokers apply the interest by adjusting your average open positions; others apply it directly to your margin balance. Most trading platforms show the interest earned or paid as a separate column in the Closed Positions panel and also as a summary. Most trading platforms will also show the amount of positive or negative rollover for each currency pair that can be traded with the platform, thereby informing the trader before the trade of the interest rate differential.

Since the amount of the interest is determined by the interest rate differential, the most interest can be earned by going long in the currency that pays the highest interest and going short in the currency that charges the lowest interest. This is the basis of the carry trade, where the trader hopes to make most of his money by earning interest rather than by trading. Currently, the New Zealand dollar and the Japanese yen have the greatest interest rate differential among the major currency pairs, with New Zealand paying the highest interest and Japan charging the lowest interest.

Countries don't change interest rates often, so a trader earning money from the interest rate differential does not have to worry about timing the market. However, the carry trade is not risk-free because adverse movements in the exchange rate can more than offset any profits in interest. In fact, the carry trade can exacerbate adverse movements in the exchange rate, because there are many traders attempting to profit from the interest rate differential, so when the exchange rate moves adversely to the carry traders, they all attempt to close out their positions at the same time, which further lowers the value of the high-interest currency against that of the low-interest currency. For this reason, many carry traders choose other currencies that also have a high interest rate, such as the Australian dollar (AUD), so that adverse moves are not magnified as much by carry traders closing out their positions.