Forex Interest Rates - Trading Tip 120807

Forex Interest Rates - Price Drivers (Part 1)

Forex interest rates are just one of the many factors that influence the movement of prices in the currency market. Over the next few weeks, I'm going to cover what these factors are and how they drive price activity.

Interest Rates

We can profit both from interest income and also from capital appreciation in difference between countries' interest rates.

Interest income is earned by buying currencies from a country with a high interest rate and financing the purchase with currency from a country with a low interest rate.

In the fall of 2006, the interest rate in Japan was 0.25% while the US rate stood at 5.25%. You could have taken advantage of this spread by borrowing a large sum of yen, exchanging them for US dollars and then using the US dollars to purchase bonds at the US 5.25% rate.

The Carry Trade

This same result is also achieved by trading the USD/JPY currency pair. This is one of the famous carry trades we hear about constantly.

Check your trading chart for the USD/JPY and the general rise you see over the past year is due to exactly this reason.

You will see interest added to your trading account by your broker to reflect the differential in the rate between the two currencies. In this case, the leverage (margin) in the Forex market makes this amount significant.

Next week I'll cover how we can also generate income from capital appreciation due to interest rate increases.

Wishing you trading success,
David Stevenson.

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