What is the Overnight Interest on CFDs

A Contract for Difference (CFD) is a type of financial derivative that allows investors to profit by predicting the price movement of an asset (such as stocks, indices, commodities, currencies, etc.) without actually owning the asset. CFD trading has the advantages of high leverage, low cost, and diversification, but it also comes with risks and fees, one of which is overnight interest.

What is Overnight Interest?

Overnight interest (also known as swap rate or overnight interest) refers to the interest income generated by investors' positions (i.e. contract shares, whether bullish or bearish) in daily settlement activities in CFD transactions. or expenditure. To put it simply, as long as the interest rate for investors buying currency is higher than the interest rate for selling currency, and there is a significant interest rate difference, they can earn overnight interest (positive overnight interest). On the other hand, if the interest rate for selling currency is higher than the interest rate for buying currency, you need to pay overnight interest (negative overnight interest).

Why Does Overnight Interest Occur?

Overnight interest exists because CFD trading involves margin and leverage. Margin means that investors only need to pay a certain proportion of funds (such as 10%) to control a larger contract value (such as 100,000 yuan). Leverage means that investors can magnify their profits or losses through margin deposits. This means that investors are actually borrowing the dealer's funds to conduct transactions, and therefore need to pay or receive corresponding interest.

How to Calculate Overnight Interest?

Each currency has its own interest rate, and every Forex transaction involves two currencies and therefore two different interest rates at the same time. In foreign exchange transactions, such as EUR/USD, buying euros means selling U.S. dollars at the same time, and selling euros means buying U.S. dollars at the same time. As long as the interest rate for investors buying currency is higher than the interest rate for selling currency, and there is a significant interest rate difference, they can earn overnight interest (positive overnight interest). On the other hand, if the interest rate for selling currency is higher than the interest rate for buying currency, you need to pay overnight interest (negative overnight interest).

When calculating specific overnight interest rates, the following parameters are mainly considered:

• The current market interest rates of the two central banks

• Price movement of currency pairs

• Forward market conditions

• Short-term money market conditions

• Dealer's fees

Overnight Interest Example

Suppose the annual interest rate of the euro is 3% and the annual interest rate of the U.S. dollar is 2%. When we sell 1 lot of EURUSD, it means selling a currency with a higher interest rate (EUR) and buying a currency with a lower interest rate (USD). So the overnight interest rate is -1% (2%-3%), the concept behind it is that we pay interest in Euros and receive interest in USD in the contract. If the dealer charges a 0.5% handling fee, which is mostly an administrative fee, but also a fee for providing leverage, the total overnight interest required is -1.5% (-1%-0.5%).

Overnight interest calculation formula:

Overnight interest = [Contract size x price x (interest spread – handling fee)] / 360 days

According to the above example, the calculation method of overnight interest for shorting EUR/USD is:

Contract unit: 100,000 Euros (1 lot); Price: EURUSD = 1.13; Interest spread: -1%; Dealer fee: -0.5%;

Overnight interest = [100,000 x 1.13 x (-0.015)] / 360 = -$4.72

This means that every day you hold this position, you need to pay $4.72 in overnight interest. If you hold it for multiple days, you need to add up the daily overnight interest.