How do swaps work in trading?

Swaps are financial agreements between two parties where they exchange cash flows based on predetermined terms. In trading, particularly in forex, swaps typically involve the exchange of interest rate differentials between currencies. When a trader holds a position overnight, they may either receive or pay a swap fee, depending on the interest rates of the currencies involved. This fee is determined by the central bank interest rates and is calculated daily. Swaps can impact the overall profitability of a trade and are essential to consider for positions held longer than a single trading day. Understanding how swaps operate helps traders manage costs and align their strategies accordingly.