Interest rates are something that affects the foreign exchange rates that traders use. However, there are other reasons why interest rates are important to traders. It is important that you know how interest rates affect the forex market and the other reasons why traders are interested in these rates. Once you understand this you will be able to see if you should also be concerned about the interest rates. The second reason why traders are interested in the interest rates does not affect all traders as it is a trading strategy that some traders use.
The Interest Rates and Foreign Exchange Rates
When looking at foreign exchange rates you should know that interest rates affect the price movements. When there is a change in the interest rates there is usually a change in the currency value. These two rates are closely linked because the interest rate can affect the demand for a currency. The interest rates will also affect the way that traders and investors view the economic state of the country.
The interest rates of a country move their currency value by the demand for the currency from investors. When the interest rate of a country is high more investors will put their money into the country. They do this to get a better return on the money so they can make greater profits. When this happens the demand for the currency increases and this increase in demand makes the currency more valuable. However, when the interest rate drops the investors pull their money from the country and the currency value goes down.
It is important for forex traders to know this and keep an eye on the interest rates. If the central bank is going to change the interest rates you need to be prepared for the impact this will have on the market. This change is a high impact fundamental which will cause a trend in the market that you can take advantage of.
The Other Reason
There is another reason for trader’s interest in the interest rates of countries. There is a trading strategy known as carry trading that takes advantage of the interest rates of currency pairs. To use this strategy you will need to have a currency pair that has one currency with a high interest rate and one currency with a low interest rate. You need to hold the high interest rates currency overnight to use this strategy.
When you hold the currency overnight you will be paid a rollover percentage. This percentage is worked out using the two interest rates. The difference between the two rates is found and you are paid that percentage of the total trade value. Of course, if you are holding the low interest rate currency you are charged this amount.
If you are going to use this strategy you need to know what the interest rates are in all the countries and find the pair that has the biggest difference. Of course, to lower the risk of this trade you should use pairs that do not fluctuate greatly. You also have to verify that your broker will pay this amount because not all of them do.