Financing cost

Definition of Financing Cost

Financing cost, also known as rollover interest, swap points, forex rollover fees, and storage fees, is the profit or loss arising from interest rate differentials between two countries.

This article will explain in detail how to calculate financing costs, the advantages and disadvantages of using financing costs in trading, and key points to note.

What Is Financing Cost?

Financing cost, referred to in other terms as "interest rate differential adjustment fee," represents the income generated due to interest rate differences between two countries.

For consistency in this article, we will use the term "Financing Cost".

As shown below, the interest rate differential between "high-interest-rate currencies" and "low-interest-rate currencies" constitutes the financing cost (profit).

financing costs

However, financing costs are not always positive and may result in "negative financing costs," meaning a payment obligation.
When "selling low-interest-rate currencies and buying high-interest-rate currencies," the financing cost is positive. Conversely, when "selling high-interest-rate currencies and buying low-interest-rate currencies," it becomes negative.

Moreover, depending on interest rate trends, the relationship between positive and negative financing costs may reverse, with both sides potentially incurring negative costs.

Calculation Method

Financing costs vary by forex broker.
Typically, they are calculated based on short-term money market interest rates and exchange rates (not policy rates), and they fluctuate daily.

Formula:
Financing Cost (USD) = Position Size × Interest Rate (%) ÷ 365 (days)

In the forex market, currency settlement (spot trading) is generally conducted on the second business day after the trade.

The same applies to margin forex trading. However, if currency settlement is performed, investors (you) may face complications, as the goal is not currency conversion.

To address this, forex brokers automatically roll over positions by closing and reopening positions to extend the settlement date, eliminating concerns about settlement deadlines.

With this mechanism, investors can continuously hold positions without worrying about delivery deadlines.

Rollovers typically occur after the New York market closes, at which point financing costs for the extended period are paid.

Advantages and Disadvantages of Using Financing Costs in Trading

This section discusses the advantages and disadvantages of trading with a focus on financing costs (aiming for financing cost profits rather than trading profits).

Advantages

The advantage of trading with financing costs is that, in addition to capital gains (profit from trading), you can also gain income from holding the asset.

As shown below, financing costs accumulate as the holding period increases.
Thus, you can expect steady daily growth in financing cost profits.

Advantages

However, market volatility could result in trading losses exceeding financing cost profits.

On the other hand, if trading profits are also realized, you can achieve both financing cost and trading profits.

In medium- to long-term trading, as financing costs increase, this advantage becomes even more pronounced.

Disadvantages

The main disadvantage of trading with financing costs is the potential for "negative financing costs" in certain currency pairs.

In such cases, instead of earning financing costs, you would need to pay the interest rate differential.

High-Interest-Rate Currency	Low-Interest-Rate Currency	Financing Cost
Buy	Sell	Positive (Profit)
Sell	Buy	Negative (Payment)

For example:

As of May 2024, South Africa's policy rate was 8.25%, and the United States' was 5.50%.
Based on policy rates, the financing costs for ZAR/USD are as follows:

Buying ZAR, selling USD: +3.00%

Buying USD, selling ZAR: -3.00%

*Buying selling

Depending on the currency pair's buy/sell combination, you might encounter negative financing costs, requiring payment of the interest rate differential.

Key Points to Avoid Mistakes in Utilizing Financing Cost

When using financing costs in trading, here are two essential points to avoid mistakes.

1: Pay Attention to the Selection of Currency Pairs

When selecting currency pairs, keep the following in mind:

Choose currency pairs with smaller spreads

Consider the interest rate differential

Choose Currency Pairs with Smaller Spreads

The spread refers to the difference between the bid price and the ask price, which acts as the actual transaction fee in forex trading.

Consider the Interest Rate Differential

Financing costs arise from the interest rate differential between two countries, making it essential to consider the interest rate gap between the currencies (countries) involved.

To benefit from financing costs, you generally need to buy the higher-interest-rate currency and sell the lower-interest-rate currency.

The larger the interest rate differential, the higher the financing costs you can earn.

However, when the interest rate differential is small, the relationship between positive and negative financing costs may reverse, requiring you to pay financing costs instead.

Therefore, it’s important to examine the interest rates of the currencies you plan to trade and select the currency pairs accordingly.

2: Manage Risks

When using financing costs in trading, consider the following:

Use lower leverage

Diversify your investments

Monitor margin ratios

Use Lower Leverage

Leverage in forex trading can also impact profits from financing costs.

For example, if you trade with an actual leverage of 10x instead of 1x, not only will your trading profits be multiplied by 10, but so will your financing cost profits.

While financing costs can steadily increase over time, large market fluctuations could put your position at risk. Using lower leverage provides a safer approach, especially when trading high-interest-rate currencies, which tend to be more volatile.

Diversify Your Investments

High-interest-rate currencies often experience large price fluctuations, making it risky to concentrate your funds in a single currency pair.

Even when using lower leverage, a single significant price movement could result in losses exceeding the profits from financing costs.

To mitigate this risk, diversifying your funds across multiple currency pairs is a viable option.
Choosing currency pairs with low correlations can further reduce risk; for instance, if one currency pair decreases in value, others may remain stable or even increase.

Although this approach may limit the profits you earn from financing costs on a single pair, it allows for long-term accumulation of financing cost profits across multiple pairs.

Monitor Margin Ratios

Financing costs are generated daily as long as positions remain open. However, once a forced liquidation occurs, your position will be closed, and you will no longer accrue financing costs.

Forced liquidation is triggered when the margin ratio falls below a certain threshold.
Even if the market trend is unfavorable, as long as forced liquidation is avoided, it is possible to continue accumulating financing cost profits over the long term.

Therefore, it is crucial to regularly check your margin ratio to avoid forced liquidation.

Financing Cost Historical Records

Financing costs vary by forex brokers and are generally calculated based on short-term money market interest rates and exchange rates.

Additionally, the financing cost payment rules differ between brokers.

Titan provides Financing Cost Historical Records, documenting the daily financing costs for each currency pair.

By reviewing the financing cost historical records to see "when" and "how much" financing cost is paid, it becomes easier to develop trading strategies.

Below is the financing cost historical record for USD/JPY as of May 7, 2024:

Financing Cost Historical Records

Date	Position	Financing Cost ($)	Duration (Days)
2024/04/01	Buy	7.54	1
2024/04/02	Buy	7.54	1
2024/04/03	Buy	22.37	3

From the historical record, it is evident that the financing cost for a buy position on Monday, April 1, was $7.54 (1 day), while on Wednesday, April 3, the financing cost for a buy position was $22.37 (3 days).

Points to Note When Trading with Financing Costs

When using financing costs in trading, consider the following points:

Financing Costs May Be Negative

As discussed in the "Disadvantages" section, financing costs can also be negative.

Essentially, holding a position with "buying a low-interest currency and selling a high-interest currency" will result in negative financing costs.

If the financing cost is negative, you will need to pay the negative financing cost daily, which incurs a loss simply by holding the position.

Of course, if the profit from market fluctuations compensates for the loss, then there is no issue.

However, if no profits are anticipated, it is wise to avoid incurring negative financing costs.

High-Interest Currencies with High Financing Costs Are Volatile

High-interest currencies with high financing costs refer to currencies associated with high "policy rates" set by their respective countries.

Such currencies often come from economies with unstable conditions and tend to exhibit significant price fluctuations.

Therefore, it is important to be cautious of scenarios where exchange rate losses could exceed the financing cost gains.

[Summary] What Are Financing Costs? Calculation Methods and Key Points to Avoid Mistakes

Financing costs represent the interest rate differentials between the currencies involved in a trade.

Positive financing costs generate daily income, but for negative financing costs, traders need to pay the corresponding amounts daily.