How rising interest rates impact your forex trading strategy

Countries around the world are raising interest rates rapidly to cope with rising inflation. Canada is no exception, with the Bank of Canada finding itself in the political spotlight over its decision to keep increasing interest rates and questions over its role in protecting against possible job losses.

Recently, the Bank of Canada raised the interest rate to 3.75%, a lower-than-expected 50-point hike. However, with that in mind, currency traders need to keep a close eye on how interest rate increases impact exchange rates.

Here’s what you need to know about how rising interest rates can impact your trading strategy.

How do interest rates impact currencies?

Rising interest rates attract global investment into a currency. In the case of the Canadian dollar, there has been more action from overseas investors because they want a piece of the action. Although inflation has spiked in Canada, the Bank of Canada appears to be set to hike interest rates over the next year aggressively.

This spells a green flag for forex traders looking to move into the Canadian market. Obviously, there is an element of risk for traders if caught unawares.

While a rising interest rate indicates a chance to make a profit, sometimes it can cause the currency to fall. The disparity between rising interest rates and perceived currency strength can mean that traders may not consider holding that currency to be worth the risk.

For example, countries increasing interest rates to support a failing currency can only do so much to stop the bleeding. Investors still need to evaluate the risk versus reward when deciding whether to move into the market.

Thankfully, this is unlikely to be a problem with the Canadian dollar, as the country remains one of the strongest economies in the world.

Carry trading opportunities

Carry trading is a popular trading strategy where investors will move into a market with rising interest rates using a low-interest-rate currency.

In the context of the current economic landscape, nearly all developed economies are raising interest rates, meaning it could be a matter of moving from a less-high interest rate currency to a higher one.

The Japanese Yen is a common currency pair for carry trading because the Bank of Japan frequently chooses to maintain a policy of low-interest rates over extended periods.

You can take advantage of carry trading opportunities as part of your trading strategy now with locally regulated brokers like Friedberg Direct. With the market moving so quickly, savvy traders have more opportunities than ever to make significant amounts on their trading activities.

Do interest rates move often?

Interest rates have remained at record lows since the financial crisis of 2008, with little movement within developed economies worldwide. Rate changes are a monumental occasion and tend to cause markets to swing.

Right now, rising interest rates are having a huge impact on the housing market, making it harder for first-time buyers to secure home loans.

Watching interest rate expectations is crucial for traders planning their moves for the future. One of the most popular markets for watching interest rate expectations is the U.S. 2-Yr Treasury.

Watch the big picture

With economic turbulence and recession expectations ahead, investors must tread carefully. Look at the big picture and avoid viewing interest rate changes with tunnel vision.

Ask yourself questions like:

• What is the current state of a country’s currency?
• How is the country’s economy doing, particularly in relation to its neighbors?
• Why have they chosen to increase or decrease interest rates at this particular time?

Remember, the key to forex trading is the relation. Analyzing one currency must be done within the context of a pair. Sometimes, one currency is doing all the work in altering interest rates, whereas sometimes, both currencies are doing their fair share.

Most traders prefer to choose stable currencies to pair with a secondary currency such as the Canadian dollar. Attempting to manage a volatile currency pair, such as the Canadian dollar and Turkish lira, should only be attempted by experienced traders.

Summary

There has never been a better time to jump into forex trading. The prevailing economic winds are producing more opportunities than ever for traders to gain exposure and make profits on their trades.

With activity comes chaos and confusion, however. Unprepared traders risk making costly missteps, meaning this is the perfect time to immerse yourself in economic news, rumours and developments from around the world.

Choose your currency pairs carefully and map out your moves to increase your chances of success. What currencies are you looking at trading right now?

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