Summary:
In foreign exchange market, overnight interest rates vary by currency pair. High-interest pairs may earn income, while low-interest pairs incur costs.
In the dynamic world of currency trading, buying and selling involve currency pairs, where logistical concerns such as storage and preservation of goods are non-existent. Consequently, the inventory fee in the forex market is essentially the cost associated with holding forex positions, commonly referred to as overnight interest. This overnight interest represents the interest either paid or earned for holding a position overnight, and it varies because each currency has its own distinct interest rate.
Normalcy of Rate Variations:
It is entirely normal for investors to encounter both positive and negative overnight interest rates in the forex market. These variations are due to the differing interest rates associated with each currency. When executing transactions in forex, holding a currency pair with a high interest rate, such as AUD/JPY, can lead to earning overnight interest income. Conversely, holding a currency pair with a low interest rate, such as EUR/USD, means you will incur overnight interest fees.
For instance, suppose you hold a long position in AUD/JPY with current overnight interest rates of 0.5% and -0.1%. In this scenario, you could earn an overnight interest income of approximately $3.3 per day, calculated as follows: 100,000 × 3.5% / 365 = $9.59. Alternatively, you might need to pay an overnight interest expense of about $1.6 per day, calculated as: 100,000 × -0.1% / 365 = -$0.27.
Implications for Traders:
Understanding these dynamics is crucial for forex traders. The presence of positive and negative overnight interest rates reflects the diverse economic environments and monetary policies across different nations. Traders must carefully select the right currency pair and determine the optimal holding period based on their individual trading strategy and risk tolerance. This strategic approach can help maximise potential returns or minimise costs in the forex market.
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