While there are many factors that contribute to the price action in forex, only a few events manage to move the markets significantly. Using such opportunities, traders could identify such moments and greatly benefit from shorting on such positions. One such key event that tends to move the markets is trading the Central bank Key interest rate decisions.
Interest rates for a country are set by their respective central banks. For example, the Bank of England for the UK, the Federal Reserve for the US, Bank of Japan for the Japanese markets, and so on.
Trading interest rate decisions requires a keen eye and an expert knowledge of the economic situations in the currency pair that you are trading. Interest rates decision happens once a month across most countries and is serious enough to move the currency market prices.
Markets usually anticipate the outcome of the interest rate decision determined by other key economic factors such as the GDP, Inflation, and consumer spending and so on. However, there are certain moments when the interest rate decisions usually take the markets by surprise.
During such moments, prices either rise or fall and set themselves up for some both short term and long term trends.
If you think that the interest rate decisions happen less frequently, then here’s some food for thought.
Most central banks in the world meet at least once per quarter with most central banks meeting almost every month. Multiply this by the major currencies such as the EUR, USD, GBP, CHF, JPY along with the CAD, AUD, NZD and you have quite a significant number of opportunities to trade during the interest rate decisions.
Traders with an eye for opportunity can easily identify such moments such as trading the interest rate decision and thus profit from this rare yet great trading opportunity.
Speculative trading on interest rates decision is ideal in the forex or currency futures markets as it allows the trader to profit from such decisions for almost any currency pair or futures contract.
For example, you could easily trade the USDJPY currency pair from London during the BoJs interest rate decision or its equivalent, the Japanese yen futures contracts.
Interest Rates Decision – what to look for?
First and foremost, the key figure that will form your benchmark is the market expectation. It is usually this number that plays a pivotal role in how the currencies will react to the decision. Analyzing the real and expected interest rates can help you identify the trends.
There are also instances when investor sentiment is so high that even in the event the interest rates are left unchanged, it could trigger a buy or a sell panic.
Besides the interest rates themselves, also be on the lookout for any press releases that might follow. It is during such events that the Central bank chiefs add context to their decisions and also indirectly set the agenda for the next interest rate decision.
Markets also tend to react to the press conferences and at times you can see a price reversal right after the press conference. The reason is because market prices are driven by demand and supply and the common denominator to both is the investor sentiment.
Market Stimulus/Quantitative Easing
Given the context of the current economic crisis, central banks left the interest rate unchanged in months as inflation and growth stalled and central banks were caught at zero or near-zero interest rates.
This is because in course of the economic cycle, when a nation hits recession (or rock bottom) the central bank has to make use of other tools in order to get the economy up and running.
When exhausting options such as using the interest rates, central banks can engage in other tools such as injecting stimulus into the markets; a refined term known as quantitative easing.
Even such tools can help to move the currency markets, albeit a bit more unpredictable.
The reason is because when the central bank injects money (or prints more money) into the economy, it usually results in currency devaluation. Therefore in order to prevent this, measures are taken so as to keep the currency price within a reasonable range.
Trading Plan Interest Rate Decisions
It is always good to be prepared when entering such crucial moments in forex trading. When trading the interest rate decisions, it is always advisable to have Plan A, Plan B and Plan C. Also spending a few minutes looking into the past history of the interest rate decisions can greatly benefit you to gain some insights into how and what influences impacted the interest rate decisions.
Avoid trading currency pairs where both the respective central banks have a trend of going in the same direction (i.e: both central banks have and will continue to raise interest rates or similar scenarios)
Considering that you have chosen the currency pair you wish to trade during the interest rate decision, your Plan A would typically be implemented if the interest rate has been increased while your Plan B would if the interest rates were decreased and finally your Plan C would be if interest were to be left unchanged.
Taking advantage of the right leverage and empowered by the above knowledge, traders can definitely benefit a couple of pips and perhaps even more when using speculative trading.