Monitoring Interest Rates in FOREX
Here are some strategies for the average trader in forex using macroeconomic terms. We know that currencies move up or down depending on several factors. One of these factors is the interest rate adjusted by governments. Governments regard interest rates as barometers for the strength of incoming foreign investment and its likelihood. But before we go deeper, let us discuss the basics of interest rates.
Of course we know the basic meaning of interest in the field of finance. However, for the purpose of forex, we shall be using its macroeconomic definition. A quick browse in Wikipedia defines interest rates as: "the main determinant of investment on a macroeconomic scale. Broadly speaking, if interest rates increase across the board, then investment decreases, causing a fall in national income." Within a country, higher interest rates mean that the people have more tendency to borrow money and that the economy is generally doing well.
Since the economy is doing well, then there is more confidence for foreign investors to invest in that country. Now at this point, forex traders come in. Higher confidence in trade means stronger currency. Now that is good.
For the government, it takes a little bit of risk to adjust interest rate as a matter of policy because of the inflation it causes. However, economists are quick to respond that a tolerable amount of inflation is necessary for growth. Hence, forex traders welcome these developments of interest rates. This is even proved by the US Dollar. Take this article from Bloomberg as an example: "Dollar Strengthens on Speculation Fed Will Highlight Inflation" published 23 October 2006. In this article, it quoted currency strategist Daniel Katzive as saying. ``The Fed may continue to emphasize inflation risks. It helps support the dollar.'
Now the strategy. Traders may capitalize on high interest rates as indicator for your currency trading behavior. Go ahead and buy that currency. However, forex is more concerned with the future rather than the present. You make more profit in currency trade if you can forecast the future trend in the currency. Hence, it is more advisable to buy in the currency where you expect more growth in interest rate. Another point though, make sure that you are using a long-term projection.
You should be able to predict not just increases in interest rate but also to predict new and strengthening currencies. At some point, it may even be wiser to invest at a currency, which may be lower at first, but with the prospect of improving and strengthening in the future. |