Foreign exchange rates are always moving up or down. There are several factors that affect the movement of FX rates. The interest rate is always an underlying factor. Interest rates are always on the minds of investors and individuals. Everyone wants to obtain a good interest rate on their investments. To obtain this they invest in bonds, money market funds and other types of investments that offer them a good rate of return in return for having use of their money.
One of the advantages of having a forex trading account is the ability of investing your money in other currencies that pay you interest. This is ideal if you can find a country with a low interest rate to use in your pairing. This is what is termed as carry trading. Carry trading is if you choose a currency pair that offers a high interest rate and one that offers a low interest rate. In this case you should hold the pair in favour of the currency with the high interest rate. If you use rollover on a daily basis, you will get paid on the difference between the interest rate of the two countries on a daily basis. In the event that you have obtained good leverage, it is possible for you to make an excellent return compared to the capital that is required to initiate the trade.
The Effect on Currencies
Interest rates affect currencies because when the interest rate is high, the country’s currency increases and this makes investors want to put their money into that country to get a good return. In cases where a country has raised interest rates for an extended period of time, it can cause a prolonged trend compared to other currencies. Investors will continue to put their money into that particular country until they get the feeling that there is a decrease looming.
Forex Trading and the Interest Rate
The negative side to this method of forex trading is the risk that is involved. Any factor that may affect global economies can cause a devastating earthquake like effect on an interest rate forex trade strategy. It does not really happen often, but if it does and you are not prepared for it, it will leave behind disaster. In 2008, during the global financial crisis, currency pairs linked to high interest rate currencies were seen to move over 1000 pips per day as the uncertainty regarding the global economy was building up. This trend continued for months after the initial shake-up, and anytime the recovery appeared shaky, small disasters would take place.
It is known for a country to have a high interest rate, yet have a currency that is on the decline. This is indicative of an interest rate that is not worth that risk. The other side of this coin is that it may be an indication that the country will experience a rate reduction in the near future.
As an investor in forex trading, you should view the full picture. Assess the country’s economy and find out why there is a lowering or raising of the interest rates.
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