Overnight Limit

What Is the Overnight Limit?

The overnight limit is the maximum net position in one or more currencies or derivatives contracts that a trader is allowed to carry over from one trading day to the next—that is, overnight. In the foreign exchange market, "overnight" technically begins after 5 p.m. ET.

Typically, traders want to hold trades overnight either to increase their profit or in hopes that a losing trade will be reduced or turned into a profit the following day. In the case of the currency markets, they may seek to benefit from a cash return, or rollover rate, on the difference between the two interest rates of the currencies they're pairing in their position.

Key Takeaways

  • The overnight limit is the position limit in a particular security or contract that can be held from the close of one trading day to the next day's open.
  • A central bank, treasury, exchange, or broker may impose overnight limits on a trader or dealer.
  • Overnight position limits can serve to manage risk, promote the stability of the financial system, and help control the flow of capital in and out of the economy.
  • Overnight limits in forex markets help traders maintain margin requirements and calculate rollover payments.

Understanding Overnight Limits

An overnight limit, or an overnight position limit, is a restriction on the number of currency positions a trader may carry over from one trading day to the next. It is also a restriction on the total size of a position or a set of positions a currency dealer may carry over from one trading day to the next.

Position limits are put in place to keep anyone from using their ownership control, directly or via derivatives, to exercise unilateral control over a market and its prices. For instance, by buying call options or futures contracts, large investors, or funds, can build controlling positions in certain stocks or commodities without having to buy actual assets themselves. If these positions are large enough, the exercise of them can change the balance of power in corporate voting blocks or commodities markets, creating increased volatility in those markets.

Overnight Limits in Forex Markets

 An overnight position in the foreign exchange market is any position (whether long or short) that is not closed (that is, settled) but remains open at the end of official trading hours, which is after 5 p.m. ET. At 5 p.m., the trader's account either pays out or earns interest on each open position depending on the underlying interest rates of the two currencies involved in the currency trade.

This payout process—the interest paid, or earned, for holding the position overnight—is called the rollover rate. The rollover rate converts net currency interest rates, which are given as a percentage, into a cash return for the position. A rollover interest fee is calculated based on the difference between the two interest rates of the traded currencies. If the rollover rate is positive, it’s a gain for the investor. If the rollover rate is negative, it’s a cost for the investor.

As a result, a rollover may show as either a credit or a debit on a trader's account. 

Calculating Rollover Payments

Let's posit that the interest rate set by the Bank of Japan (BOJ) is 1.25% and the federal funds rate set by the Federal Reserve is 2.5%. You decide to open a short position JPY/USD for 100,000, commonly known as a lot in the retail FX arena. Here, you are primarily selling 100,000 JPY, borrowing at a rate of 1.25%.

In selling JPY/USD, you are buying USD, which pays out at 2.5% interest, and selling JPY, which costs 1.25%. When the interest rate of the country whose currency you are buying is less than the interest rate of the country whose money you are selling, your account receives a credit for the difference, as in the example above. If the interest rate is higher in the country whose currency you are selling, your account will show a deduction for the difference. Also, a forex broker may also charge fees at the same time that storage is added or subtracted from your account.

Reasons for Overnight Limits

central bank, treasury, or forex broker may impose overnight limits on a trader or dealer of currencies. A forex (FX) trading business enterprise, such as a hedge fund, may impose overnight position limits for its traders as a risk management strategy.

Overnight position limits serve a variety of other purposes:

  • A financial regulator like a central bank, or the U.S. Commodity Futures Trading Commission (CFTC), may impose them to promote the stability of the financial system.
  • A central bank may institute asymmetric open position limits that discriminate between long and short currency positions.
  • A government's treasury or finance department may set limits between residents and nonresidents to help control the flow of capital in and out of the economy.
  • A bank or other financial institution may impose limits on its customers or traders to manage risk.

Special Considerations

Unlike the stock and bond markets, holding an overnight position is not a major concern in the online, global forex market, which technically allows for seamless 24-hour trading. However, most currencies, and currency pairs, have much higher volume and stable moves when the European and U.S. markets are open. Lower volume during the off-hours can result in volatile, random swings caused by small groups of traders or large orders. So, if a trader can't close a position before the day's end, they may prefer to hold overnight, waiting to resume trading during a more active time, rather than risk it during the quiet time.

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