What is the Overnight Limit?
The overnight limit is the maximum net position in one or more currencies that a trader is allowed to carry over from one trading day to the next.
- The overnight limit is the maximum net position in one or more currencies that a trader is allowed to carry over from one trading day to the next.
- A central bank, treasury, or forex broker may impose overnight limits on a trader or dealer of currencies.
- 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.
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.
An overnight position in the foreign exchange market is any position which remains open after 5:00 p.m. EST. Currency trades execute in currency pairs. All forex trades involve the simultaneous purchase of one currency and sale of another, but the currency pair itself is a single unit. At 5:00 p.m., the trader's account either pays out or earns interest on each open position depending on the two currencies' underlying interest rates. This payout process is called a rollover. Rollover may show as either a credit or a debit on a trader's account.
A 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 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.
- These limits may also be set 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 overnight position limits on its customers or traders to manage risk.
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.