Q. “I see one of the more hidden costs of CFDs is Swaps.
I trade on the Velocity Trader platform and I see the costs are increasing due to Swaps. For some CFDs (eg JSE: BID) is now larger than the actual initial fee for the trade. What exactly are they charging me for here and is there anything I can do to reduce this fee? I am certainly not actively swapping anything or making any changes to these positions.”
A. It’s an important question, and I love that you’re taking the time to interrogate your fee structure.
This is an important step to becoming a successful trader.
It is crucial to understand the mechanics of what you’re paying for and why it is absolutely critical for your money management.
Let’s start with the name.
What does “Swaps” mean?
“Swaps” on the Velocity Trader platform are the costs of financing your position.
Depending on who you speak to you might hear different terms.
I first learned to call this charge “cost of carry”.
But these days it’s synonymous with “funding charge”, “overnight fee” “daily interest charge” or “financing fee”.
The Velocity Trader system just happens to call it “swaps”.
But what are “Swaps” on Velocity Trader?
Swaps are the interest that you pay on borrowed (leveraged) money when trading.
Most trading instruments have leverage (gearing) built into them.
This means:
1. You get to trade with other people’s money instead of your own.
2. It multiplies returns (and losses) on small movements in share prices.
3. It keeps your capital requirements low, allowing you to effectively deploy the bulk of your capital elsewhere.
Let’s use a Bidcorp trade as an example.
I sent out a long recommendation on Bidcorp on the 28th of June 2023.
The entry was at R404.50.
The margin per contract was R41.63.
That means for each CFD I buy, I get R404.50 worth of Bidcorp with only a margin deposit of R41.63 of my capital.
So where does the rest of the money come from?
This is financed.
For each Bidcorp CFD I buy, I pay R41.63 in capital and the bank gives me R362.87.
R362.87 + R41.63 = R404.50
But, unfortunately, banks don’t give away money for free.
On the R362.87 they will charge a funding rate or “swap”.
The funding rate is based on the prevailing interest rates at the time.
So the higher the daily interest rate, the more you will pay on the long (buy) positions.
The good news however is that, if you’re short, you will actually get paid the financing cost.
The long annual Swap rate on Bidcorp was-11.49% and the short swap rate, +5.49%.
This means per day you’d pay 0.03147% with interest.
And if you held over the next 365 days you’d pay 11.49%
This fee moves with South African interest rates.
There isn’t much you can do to change it unfortunately as it’s set by the banks and SARB and even the brokers are price takers in this situation.
In the case of Bidcorp we were paying 11.49% per year on the R362.87 borrowed per contract.
So roughly the position was costing roughly 11.4c per day, per CFD to keep the trade open.
(R362.87 x 11.49%) / 365 = 11.4c
So if you bought 100 CFDS it would cost you R11.42 per day to hold the position.
The position was open for 20 days.
So with buying 100 CFDs, the Swap cost would be around R228.46 for the period.
But as we banked the position for a profit, let’s look at how that affects the overall gain.
With the 100 CFDS we bought at R404.50 and sold at R423.80.
The difference (remember we’re trading Contracts for Difference or CFDs for short) is R19.30 (R423.80 – R404.50)
So 19.30 x 100 contracts gives you R1,930.00 profit minus the R228.46.
This gives you R1701.54 clean profit. To get trades just like this one, join Global Macro Trader here.
No doubt it has an impact.
So, why do I largely ignore swaps when discussing trades?
There are a few reasons.
First and foremost, my goal on this service is to pick good levels and trades.
My focus is on making sure I’m buying low and selling high.
Or in the case of a short, selling high and buying low.
The key information for readers is the entry and the exit levels.
I’m always trying to make as much money as possible as safely as possible.
These can be long positions or short positions. And really, there should be roughly an equal number of longs and shorts going out on this service.
It just so happens this year, I’ve been seeing far more BUYS than SELLS. It so happens that of the 20 closed trades only 3 trades went in the wrong direction.
So yes, I’ve been sending out many more buys in 2024, but it’s clear that they have been the right call.
It also doesn’t mean I won’t be sending out a lot of shorts soon!
Markets change!
But the assumption is that being roughly balanced the carry should more or less offset across the service.
Secondly, I personally choose to trade CFDs rather than equities in my account.
And my promise on this service is to show you what I’m doing when I trade.
Some traders that follow this service (and I know this) actually trade the underlying equities directly.
So in the case of Bidcorp, they had spare cash and chose to buy at R404.50 and sell at R423.80.
However, they decided to fund the whole deal.
In other words, in the example above, they would have put down R40,450 and bought 100 shares instead of R4,163 buying 100 CFDs.
The share trader would have made exactly the same absolute profit result.
The difference however would have been in how their fees were charged.
They would have NOT paid the R228.46 in Swaps (and this is a way you can avoid Swaps i.e. by trading the underlying shares).
But they also would have paid additional transaction fees on the shares.
Remember if you trade the underlying share directly you have pesky fees like STRATE, the Investor Protection Levy or International Stamp duty depending on the instrument.
This makes the transactional cost more expensive.
I know personally that I usually hold a position for no more than three weeks, so the Swap fee ends up cheaper than the higher transaction cost (for me personally).
Of course you should trade how you see best.
Maybe trading the underlying equity would suit you better.
Finally, the cost of the capital.
I could easily trade the underlying equity.
My CFD account is not my primary investment.
It’s a high-risk account that I use to try and multiply my annual gains.
So the final assumption I make is that while I’m paying 11.49% on the carry cost, I’m not only getting the transactional fee reduction, but that extra money I earn by not having my capital tied up in my trading account.
I can tell you the balance of my funds are parked in a great long-term investment vehicle that has delivered well in excess of the 11.49% swaps
I’m paying now.
So, I assume that that carry fee is also to a large degree being offset for me by the interest being earned on the capital I’m not using for trading!
I hope that clears up the Swap fees, why we pay them, and why I trade this way rather than just the direct underlying shares.
