What Is a Swap-Free Trading Account and How Does it Work?

Online trading is open and available to anyone who is interested. It is not exclusive to any particular profession, country, or geographic region. You need to open an account, deposit funds, and start trading at any time.

Although day trading does not have any restrictions or limitations in this regard, some religious groups may face various restrictions from trading the markets due to their beliefs. This is where swap-free trading accounts come in.

What is Swap in Trading?

Swap is the interest paid or received for holding positions overnight. It can be negative or positive based on the interest rates of the currencies you are trading. However, since not everyone can pay or get such fees, most traders offer swap-free options.

A swap-free trading account is free from swap fees, which means that traders neither pay nor receive the fee (swap).

What is a Swap-free Trading Account?

Just as the name implies, this is a trading account that does not generate swaps. A ‘swap’ is a rollover interest or commission that brokers charge when traders keep their position open for more than a day (overnight). This means that you can trade without incurring any overnight fees.

A swap-free trading account does not generate interest, making it ideal for Muslim traders. These are the only types of interest-free trading accounts and they have become quite popular among Muslim traders.

Even though swap-free accounts typically used by Muslim traders, non-Muslim traders can also use them including other groups that face restrictions in forex trading due to religious beliefs. According to Islamic law, engaging in a business or contract that involves charging and/or receiving interest (or riba) is forbidden. However, exchange of currency is allowed. This is according to the teachings of Prophet Mohammed. ^[1]

Swap-free trading accounts were created in order to allow traders to participate in the markets regardless of their faith and beliefs. Although the debate as to whether swap-free trading accounts are halal continues to this day, the final decision depends on the individual.

Muslim traders believe that swap-free trading accounts sufficiently address the restriction against interest. This is the main reason why swap-free trading accounts are also known as Islamic trading accounts.

How is Swap Calculated?

Online brokers usually pay or charge differential interest of currency pairs if positions are carried over to the next day. At the end of a trading day, you have the option to maintain your position overnight. This will generate interest, which brokers will either add (pay) or deduct (charge) to the client’s account. This is standard practice in some markets, including Forex trading and gold trading

The interest is generated from fluctuations in exchange rate that occur overnight while the financial markets are closed.

What Happens When You Leave Your Position Overnight?

If the currency you are buying has a higher interest rate compared to the currency you are selling, you earn interest which your broker will add to your account. However, if the currency you are selling has a higher interest rate than the currency you are buying, then your broker will deduct the differential interest from your account.

It is important to note that interest can either be negative or positive. Differential interest is the difference between a currency pair’s interest rates. For instance, suppose you want to buy Euros and sell US dollars. For example purposes, if the Euro has an interest rate of 4.5% and the dollar’s is 3.7%m the differential interest rate will be 0.7%.

The rollover amount formula = (differential interest – broker’s commission) lot price

                                                               365 (number of days in the year)

The rollover amount is the amount that will be added or deducted from your account.

Keep in mind that this can be a little as a few dollars a night or as much as hundreds or thousands of dollars.

How do Swap-free Accounts Earn?

Swap-free accounts or Islamic accounts earn revenue solely through foreign exchange. In addition to eliminating the restriction of interest, it also gets rid of the restriction of gambling, which is strictly forbidden by Sharia Law. Before you fully immerse yourself in active trading, you should understand all the risks involved with trading on margin and the currency market in general.

Reference

1. “Riba Definition – Investopedia.” https://www.investopedia.com/terms/r/riba.asp. Accessed 22 Apr. 2022.