Capital Appreciation - Price Drivers (Part 2)

Capital appreciation is another of the many factors that influence the movement of prices in the Forex market. Last week we covered how interest rate differentials can create profits.

This week's tip is to show you how changes in a country's interest rate effect the value of their currency.

How Do We Use It to Generate Income?

Investors will generally seek currencies with higher interest rates which contributes to this appreciation.

If we look at the USD/JPY spread in 2005 and 2006, as the US interest rates stayed higher than Japan's, the dollar continued to increase in value. Investors who traded yen for dollars gained from interest income (as explained in last week's tip) as well as the increase in the US dollar's strength.

Interest rates can be used to trade currencies using both long and short-term perspectives. When thinking long-term, we look for major themes. On a short-term basis, we look for surprises in the news that shift the market’s interest rate expectations, such as changes in a country's consumer price index (CPI).

Surprises in CPI often trigger price rallies which can last for weeks. Expectation of interest rate increases or reductions often change as CPI numbers are reported. Watch for these and trade accordingly.


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