A synthetic position in forex trading is a position constructed from two or more forex positions with two or more common currencies. For example, if I have a position in the GBPJPY and another in the NZDJPY, you may have a synthetic position in GBPNZD depending on the direction and lot size of the JPY currency for each position.
If you trade a portfolio of currencies you will want to make sure you are performing analysis on any synthetic positions you have as all your positions when accumulated may show you positioned heavily in a particular direction according to the synthetic position you have on.
Why synthetic positions?
Reasons for why you should understand and know about synthetic positions are as follows:
Instead of opening or having multiple currency positions open at once, you might be able to compress your positions into one upon your analysis of the overall synthetic position of your portfolio.You may be able to analyse what your synthetic position from all open trades in your portfolio and thereby mitigate the risk by opening positions in the synthetic pair.You may be able to create a synthetic position if your forex broker doesn’t offer the currency pair you are hoping to trade.You may be able to achieve a tighter spread with a synthetic position than you otherwise would trading the physical currency pair.
In this article we will emphasise the second point raised above by exploring the opportunity missed if our forex broker doesn’t offer a currency pair that pays interest on currency positions.
What is a synthetic position?
The best way to explain a synthetic position is by way of demonstration.
Currently, Oanda does not offer the ability for forex traders to trade on the NZDJPY currency pair directly. One advantage of trading this currency pair is that at this present moment being long NZD has an interest payout of 7% per year, whereas being short JPY is a charge of 0.32% per year.
Therefore, if you can achieve going long NZD and short JPY and can hold this position you’d be pocketing the difference every day.
So what do we do?
All interest rate charges and payments have been taken from Oanda’s Interest Rate section.
How can you construct a synthetic position of NZDJPY in Oanda?
We could do it any manner of ways:
Long USDJPY & long NZDUSD.Long GBPJPY & long NZDGBP.Long EURJPY & short EURNZD.
Can you see the pattern?
If we’re trying to achieve a synthetic position of NZDJPY we have to find a way to neutralise the common currency in both positions.
Before we look at a synthetic position, let’s first understand how interest has been calculated on any currency position.
We’ll look at the volatile GBPJPY pair, currently Oanda pays the following:
Long GBP positions pay at 4.35% per annumShort JPY positions charged at 0.32% per annum
If we were to go long GBPJPY (which in effect is buying/investing Pounds and selling/borrowing Yen) then we’d receive interest on a daily basis, as the interest received is greater than the interest paid.