Due to its decentralized nature and multiple time zones, the forex market operates 24 hours a day, five days a week. However, every day, there is a certain period known as the “swap period” or rollover period’, which can be treacherous for traders. During this short period, usually around 17:00 New York time (or 22:00 GMT), liquidity tends to dry up, spreads widen, and price movements become highly volatile, resulting in price slippage. Understanding the dynamics of the swap period is critical for traders who want to navigate the challenges and opportunities it presents.
What is a swap period?
A swap period occurs when the forex market moves from one trading day to another. During this period, brokers charge a fee to swap (or overnight commission for clients from Muslim countries) for positions that remain open after a certain time. Depending on the interest rate differential between the two currencies in the pair, traders may be charged or debited for holding their positions overnight.
What makes the swap period particularly risky, however, is that most liquidity providers temporarily withdraw from the market or significantly reduce their operations. Large financial institutions and banks acting as liquidity providers tend to limit their operations during this time, causing liquidity to dry up. As a result, traders face several risks, including slippage, increased spreads, and sharp price fluctuations. And it is not the brokers’ fault.
Consequences of low liquidity during the swap period
1. Spread widening
As liquidity providers temporarily withdraw from the market, brokers have fewer sources to obtain competitive prices. Consequently, they widen spreads to account for the increased risk and lack of price competition.
Example: On a currency pair whose spread during active trading sessions is typically 1 pip, spreads can increase to 10 pips or more during the swap period. This can result in significant costs for traders attempting to open or close positions during this time, especially for those using high leverage.
2. Price spikes
Another noticeable effect is the increased likelihood of sharp, volatile price movements. With fewer orders in the market, even small trades can outsize price movements, causing price spikes or drops. Such movements often have no fundamental basis and can take traders by surprise, potentially triggering stop-losses or stop-outs for those with open positions.
Example: A large market order placed in a low liquidity environment can cause a significant price movement. This is particularly risky for traders holding large positions, as even a small shift in price can result in significant losses at that time.
3. Low Liquidity
During the swap period, the number of available buyers and sellers diminishes as most liquidity providers reduce or halt their activity. When fewer participants are in the market, orders have a harder time finding matching counterparts. This creates gaps in pricing, leading to trades being filled at less favorable prices. As a result, trader’s orders are often executed with slippages during this period, especially on market orders that guarantee execution but do not guarantee the exact execution price.
Example: A trader sent a buy market order on EUR/USD during the swap period at an expected price of 1.1400. Due to low liquidity and rapid price fluctuations, the order may be executed at 1.1410 or 1.1420, resulting in a slippage of 10 or 20 pips. This slippage would likely be null in normal trading conditions with tighter spreads and more liquidity.
Slippage during the swap period can have serious consequences, especially for traders using short-term strategies such as scalping or day trading, where accuracy is critical. Even a small slippage can wipe out profits, turn winning trades into losses, or amplify losses on trades already moving against the trader.
Slippage can also cause stop-loss orders to be executed at much worse prices than intended. For example, suppose a trader has set a stop-loss order to minimize losses at a certain price. In that case, slippage can push the execution price well beyond that level, resulting in larger-than-expected losses.
Leveraged traders are particularly vulnerable to slippage risks during swap periods. Even minor slippage can result in significant losses at high leverage levels, triggering the need for margin calls or account liquidation.
How do you trade in the swap period, then?
Given the increased risks during the swap period, including slippage, to minimize losses, the trader should:
1. Avoid trading during the swap window
The easiest way to avoid slippage and other risks is to refrain from trading during the swap window. Most experienced traders prefer to avoid this window by trading before or after it to take advantage of better liquidity and tighter spreads.
2. Use limit orders instead of market orders
Limit orders allow traders to set a specific price to execute a trade, which helps avoid slippage. While market orders are executed at the best available price (which may be far from the expected price during the swap period), limit orders provide execution control and can protect against volatile price spikes.
3. Reduce position size
By reducing position size during swap periods, traders can limit their exposure to price spikes, slippage, and increased volatility. This strategy helps manage risk while maintaining open positions when necessary.
Conclusion
Trading during the Forex swap period presents unique challenges, including low liquidity, wider spreads, sharp price spikes, and significant slippage. While some traders may find opportunities to capitalize on these conditions, the risks are substantial. Slippage, in particular, can negate profits and amplify losses, especially for traders using high-leverage or short-term strategies. Also, remember that the broker will not compensate you for losses during the swap period, even if you have taken a loss on a spread widening or large slippage. Why? Because these are real market conditions and pricing, it is not the broker’s fault. Therefore, the best approach for most short-term traders is to avoid making trades during swap periods altogether.
