In the example featured in Part 4 of Currency Trader Basics with the USD/JPY, between 2005 and 2006, the US Federal Reserve was aggressively raising interest rates from 2.25% in January to 4.25%, an increase overall of 200 basis points. Over the same period, Bank of Japan was sitting on its hands leaving their interest rate at zero. As such, the spread between Japanese and US interest rates stretched from 2.25% (2.25% – 0%) to 4.25% (4.25% – 0%) in what is called an expanding interest rate spread.

Pick Forex carry trades benefiting from a positive and growing yield with potential for appreciation in value. For the currency trader who wishes to play hard but with calculated risk this is important; for as easily as any currency appreciation could increase the value of carry trade earnings, any currency depreciation could just as easily completely eradicate your carry trade gains.

Getting to Know Interest Rates

Knowledge of where interest rates might be going is important for forex traders and requires a solid understanding of the underlying economics of the country in question. As a generalization, countries performing very well, displaying a strong growth rate and increasing inflation would usually raise interest rates in an attempt to control growth and tame inflation. Conversely, countries facing more difficult economic conditions perhaps due to a broad slowdown in demand to a full recession would probably consider the possibility of an interest rate reduction.

Conclusion

Electronic currency trading networks, providing widespread availability in forex trading has made the world’s largest financial market more readily accessible than ever, offering a world (literally) of opportunity to investors who bother to take time to understand it and pay attention to how best to mitigate the risks of trading here.

Be Sociable, Share!

•