Forward Points forex: Ultimate Guide to Calculation & Trading

Forward points, also called swap points, show the difference between the forward exchange rate and the spot exchange rate of a currency pair.

They mainly help calculate the forward price for a currency. This price isn't a guess. It shows the interest rate difference between two currencies.

We will explain what forward points are, why they exist, and how to calculate them. We'll also show how to read them in real trading and use them wisely.

Deconstructing Forward Points

To understand forward points, we need to know about two key rates: the spot rate and the forward rate. These are the basic parts of foreign exchange.

Spot vs. Forward Rates

The spot rate is the price for immediate settlement of a currency trade. In forex markets, "immediate" usually means within two business days (T+2).

A forward rate is a price agreed on today for a currency exchange that will happen on a specific future date. This could be 30, 90, or 360 days later.

Forward points bridge the spot rate and the forward rate. They adjust the spot rate to find the forward price.

Not Future Predictions

Many people think a forward rate predicts where the spot rate will be in the future. This is wrong.

Forward rates don't come from guessing. They are calculated from the interest rate difference between two currencies to prevent risk-free profit chances called arbitrage.

The system creates balance, making sure that after counting interest earned, it costs the same to buy a currency today as it does to lock in a future price.

The Engine of Forward Points

The main driver of forward points is the interest rate difference between two countries. A key economic rule explains this.

Interest Rate Parity

This rule is called Interest Rate Parity (IRP). It says investment returns should be the same in any currency once exchange risk is removed.

Think of it this way: You could invest money at home and earn local interest. Or you could change your money to a foreign currency, invest it abroad for foreign interest, and lock in a forward rate to convert back later.

IRP says both paths must give the same result. If they didn't, someone could make risk-free profit. Forward points keep this balance.

How Interest Rates Work

The relationship is simple. The currency with higher interest rates will cost less in the forward market. The currency with lower interest rates will cost more.

Let's look at two cases. If Currency A has higher interest than Currency B, people want Currency A because it earns more interest. To stop everyone from just buying Currency A, the market adjusts. The forward rate for Currency A drops by subtracting points. This balances out the higher interest gain.

If Currency A has lower interest than Currency B, its forward rate will be higher. The forward price goes up by adding points. This makes up for the lower interest you'd earn compared to holding Currency B.

For example, if the US rate is 5.5% and the European rate is 4.5%, the US Dollar has higher interest than the Euro. So the USD will have a lower forward price compared to the EUR.

Calculating Forward Points

Let's move from theory to practice. We can calculate forward points using a standard formula and apply it to a real business case.

The Core Formula

The formula to calculate the adjustment for a forward rate is:

Forward Points = Spot Rate × [((1 + Quoted Currency Interest Rate) / (1 + Base Currency Interest Rate)) - 1] × (Days to Maturity / Day Count Convention)

Each part means:

• Spot Rate: The current exchange rate for the currency pair.
• Quoted Currency Interest Rate: The interest rate of the second currency in the pair.
• Base Currency Interest Rate: The interest rate of the first currency in the pair.
• Days to Maturity: How long the forward contract lasts (e.g., 90 days).
• Day Count Convention: Usually 360 for most currencies, but can be 365 for others like the British Pound.

A Practical Example

Let's work through a common situation. A US importing company bought goods from a German supplier and needs to pay €1,000,000 in 90 days.

The company wants to lock in the EUR/USD exchange rate today to avoid the risk of the euro getting stronger against the dollar. Here's how to find the forward rate they can secure.

First, we list what we know:

• Currency Pair: EUR/USD
• Spot EUR/USD Rate: 1.0850
• US Interest Rate (Quoted Currency): 5.5% (or 0.055)
• Eurozone Interest Rate (Base Currency): 4.5% (or 0.045)
• Days to Maturity: 90
• Day Count Convention: 360

Next, we put these numbers in our formula.

Forward Rate Adjustment = 1.0850 × [((1 + 0.055) / (1 + 0.045)) - 1] × (90 / 360)

Let's solve step by step.

Interest Rate Differential = (1.055 / 1.045) - 1 = 1.009569 - 1 = 0.009569

Time Factor = 90 / 360 = 0.25

Forward Rate Adjustment = 1.0850 × 0.009569 × 0.25

Forward Rate Adjustment = 0.002595

In market terms, this is often shown as points. Since forex rates usually have four decimal places, 0.002595 rounds to 0.0026, or 26 points.

Finally, we calculate the full forward rate. Since the quoted currency (USD) has higher interest, the base currency (EUR) costs more. So we add the points to the spot rate.

Forward Rate = Spot Rate + Forward PointsForward Rate = 1.0850 + 0.0026 = 1.0876

The US company can make a forward contract to buy €1,000,000 in 90 days at a guaranteed rate of 1.0876. They have protected themselves from currency risk.

Reading Market Quotes

On trading screens or quotes from banks, forward points come as a two-way quote. You need to know how to read them.

The Two-Way Quote

Forward points show as two numbers, like 25 / 26. This shows the bid/ask spread for the points.

The first number (25) is the dealer's bid price, where they will buy the base currency forward. The second number (26) is the ask price, where they will sell the base currency forward.

Your position decides which number you use. If you're selling the base currency forward, use the first number. If you're buying, use the second.

Ascending vs. Descending

The market has a simple rule for knowing whether to add or subtract points from the spot rate. It depends on whether the numbers go up or down.

If the points go up (e.g., 15 / 18), you add them to the spot rate. This means the forward rate costs more than the spot rate.

If the points go down (e.g., 18 / 15), you subtract them from the spot rate. This means the forward rate costs less than the spot rate.

This small/big rule helps traders quickly calculate forward rates.

Quote Type	Example Quote	Action	Result
Ascending (Premium)	Spot: 1.2500, Fwd Pts: 15/18	Add to Spot	Forward Bid: 1.2515, Fwd Ask: 1.2518
Descending (Discount)	Spot: 1.2500, Fwd Pts: 18/15	Subtract from Spot	Forward Bid: 1.2482, Fwd Ask: 1.2485

Strategic Implications

Different market players use forward points for different goals. Understanding these helps explain market behavior.

For the Hedger

A company treasurer is a hedger. They want to remove uncertainty and protect profits from currency changes.

Hedgers use forward contracts to lock in future exchange rates for payments or income. This turns an unknown future cost into a fixed, known amount.

For the Speculator

A forex trader is often a speculator. They want to profit from predicting market moves.

A speculator might use forwards if they think interest rate differences between currencies will change. They might also bet that the future spot rate will differ from what today's forward rate suggests.

For the Arbitrageur

Arbitrageurs seek risk-free profits by finding temporary price mistakes in the market.

If they notice a difference between the theoretical forward rate and the actual quoted rate, they can make trades. They borrow in one currency, convert at spot, invest in the second currency, and sell it forward to lock in a guaranteed profit without risk.

Points vs. Outrights

Finally, let's clear up two related terms that cause confusion: forward points and forward outrights.

Forward points are the adjustment. They are the number of pips you add to or subtract from the spot rate.

A forward outright is the final, total price. It comes from: Spot Rate +/- Forward Points.

Think of forward points as the "adjustment amount" and the forward outright as the "final locked-in price" for the future trade.

Key Takeaways

Understanding forward points is essential in foreign exchange. They aren't random numbers but reflect basic economic principles.

• Forward points show the interest rate difference between two currencies.
• They help calculate the forward exchange rate from the spot rate.
• Forwards are important tools for hedging, speculation, and arbitrage.
• Knowing how to calculate and interpret forward points is a key skill in international finance.