Also known as a foreign exchange swap or an FX swap, the forex swap is an investment strategy that is a combination purchase and sale of the same amount of one currency, while purchasing a different currency that carries two different value dates. This essentially creates a situation in which the investor offsets the sale with the purchase, and also positions the investor to earn a return in both a short and a long position. A forex swap is not the same as a currency trade, which is a simple exchange of currencies based on the current performance of one currency against the other.
While somewhat more complicated than a currency swap or exchange, the forex swap also carries the potential to make a great deal of return. There are actually two parts to the process that have an impact on the foreign exchange balances held by the investor. The first is known as a spot foreign exchange transaction, which is a quicker delivery date, usually immediate. The second component is known as a forward foreign exchange trade or transaction and helps to position the investor to earn a return over a longer period of time.
The end result of this dual nature of the forex swap is that it leaves the investor with a long position with one currency, and in a short position with the other. The long position is considered positive and earns interest over a longer term for the investor, assuming the trader can accurately determine what the currency position will make or cost, based on the movements on the market. It is important to note that change is much swifter on foreign exchange markets than with the trading of stocks and bonds, making this type of investment activity much more volatile. For this reason, constantly keeping up with events that can impact the relative value of the currency is very important to earning a decent return.
The forex swap is not something that first-time investors with currency trading should take lightly. Making the right purchase and sale at exactly the right time requires careful planning, and a good idea of what is happening in the market right now, as well as what can reasonably be expected to happen before the close of the trading day. It is often wise for novice traders to try a forex swap with currency that is relatively stable, in order to gain some experience with executing the strategy to best advantage. As the investor becomes more comfortable with the particulars of investing in currency, it is possible to successfully complete more ambitious swaps of this type, and increase the return that is earned.
