Interest rates and their importance for traders

Ted Capwell

In order to achieve astounding results and highly-accurate indicators through market analysis, you must have a deep understanding of basic economic and financial concepts. Today we propose going through the incredibly influential topic, in terms of the financial market, of interest rates. In doing this we will go through thoroughly the concepts, approaches to calculating this indicator, level of influence on trading rates, as well as the various ways of using the rate changes when trading. When the market is overbought, it gives you the opportunity to increase its potential in regards to the professional quality of market analysis based on financial tools.

So, interest rates are a basic tool used by market regulators in relation to monetary policies on the governmental level, as well as on the level of the economic sectors. Therefore, government tools regulate the most important drivers in this or that financial sphere in economically critical situations. This indicator has a macroeconomic character, linked to one of the most influential and powerful drivers for shifting market conditions, including sharp spikes in market volatility.

When considering interest rates within the context of trading, it is worth noting that the vast majority of traders closely follow the shifts in this indicator, as every interest rate correction leads to impulsive market movement, resulting in astounding profits or serious losses in any case. Let’s go through all the finer details.


Interest rates and their importance for traders


What Are Interest Rates?

As we mentioned before, interest rates are a tool of government departments that regulate the economy. Through this tool, the government can either limit access to funds or, conversely, create the opportunity to borrow money very affordably. Therefore, when the economy is growing at too fast a pace, the government raises interest rates, if it has collapsed or stagnated, regulators decrease rates, making funds more accessible.

To put it into plain language, interest rates are an indication of a government’s assessment of the current market situation and also the cost of borrowing for the banks.

Therefore, by artificially manipulating rates for borrowing, either by limiting access to affordable loans or stimulating lending, the government aims to support the smooth and stable growth of their economy. On the forefront of this, interest rates begin to heavily influence the value of the national currency, causing spikes and fluctuations of other assets on the financial market.

Which is why it is vital for every online trader to analyze and forecast the shifts in this indicator. Once you have correctly familiarized yourself with the possible shifts in the rates, you, in turn, will gain have a very effective approach to technical analysis at your disposal, the ability to earn profit not only in long-term investments but through day trading as well.


Forecasting Rates

Typically, online traders evaluate the general economic situation of the country that issues the financial tool in order to forecast the rates. For example, traders take into account the economic situation in the US in order to have an understanding of what measures the Federal Reserve will take in terms of the interest rate. This in principle helps with analysis and forecasting the indicator. However, this approach doesn’t produce concrete data or rate reversal points. In order to forecast more precisely the possible actions, on the part of the regulator, in terms of interest rate policy changes, you must pay close attention to more concrete financial, economic and social indicators. The following are a basic list of the influential drivers that most affect interest rates:

● The Employment Levels
● The Consumer Price Index
● The Housing Market
● The Cost of Subprime Lending

Impulsive shifts in the specified indicators, either positively or negatively, are the precursors of further changes in term of lending policies, therefore in the interest rates. When analyzing interest rate drivers, you can set more concrete time frames and vectors of possible shifts, enabling you to make any corrections to your trading plan that are necessary.

It works relatively simply: if the aforementioned indicators grow at an average rate, then interest rates will remain stagnant or rise slightly. It signifies the healthy economic growth of the country, and, therefore, the attractive perspective growth of financial assets connected to that economy. If the indicators rise too quickly, the government is usually trying to lower the pressure on the economy by raising the rates. It is vital for preventing financial crises. And, conversely, when the indicators of the specified drivers fall sharply, regulators lower them, so that the financial market and the economy are filled with cheap funds, enabling growth. The collapse of rates usually signifies serious systemic problems in the economy of that country.

Besides clear technical financial drivers for forecasting interest rate shifts, there are also several unusual tools for detecting changes in lending policy:

● Statements of Central Bank Management – In order to forecast shifts in the interest rates, it is worth paying close attention to statements made by top management of central banks. The issue is that government bodies, like other bureaucratic systems, aren’t quick to apply regulatory norms. Hence, the question of raising and lowering rates is considered for lengthy periods of time, and any changes are announced long before the final decision.

Which is why it is important to listen closely to heads of central banks or the committee members who set interest rates, so as to better work out when and what kind of indicator changes will take place.

● Analyze Forecasts of Systematic Traders – The second approach to forecasting interest rate changes is utilizing the analysis of systematic traders. This issue is that announcements regarding changes in lending policy push big-time investors and banks to analyze the situation. In this case, not only largely analytical resources are being utilized, but administrative ones as well. Therefore, calculation compiled by large banks or investment funds can become a great foundation for forecasting rates. Typically, private investors are satisfied with utilizing the forecasts of two or three systemic traders to calculate a simple average that defines possible interest rate changes.

As you can see, there is nothing complicated about it at all. However, to ensure the quality of the analysis, you should consider various different indicators, and for that, you must be familiar with all the nuances of working with the financial market.
When forecasting changes in interest rates, despite fairly well-defined circle of drivers, there are times when regulators come to unexpected decisions that provoke strong market movements. On that note, there isn’t anything that can be said on the matter!
Regulators come to unforeseen conclusions or unexpectedly adjust interest rates in the following situations:

● Political reasons for the financial indicator’s change. This typically is caused by a change in approach taken by a new government, planning radical reforms to the national economy or financial sector

● Due to this, there is either a sharp decline of the financial sector or wide-spread economic stagnation
In such situations, possible rate changes won’t be announced early, it will all happen instantly. When this happens, online traders should be prepared for strong impulsive changes in asset volatility, therefore increasing the financial risk involved for traders. Usually, professionals advise against placing trades on the market.

Now, we propose considering how interest rates influence specific trading tools. This is fundamental to having a basic understanding of how this indicator influences specific assets.


Rates and Bonds

When calculating the profitability of government bonds, interest rates play one of the most influential roles in the indicator. The issue is that in this case, the bond’s income is equally, but conversely dependant on interest rate changes. So, when the interest rate rises, bond’s profitability always falls, and vice versa, when the rate declines, the bond increases in value. In general, changes in a bond’s’ value or profitability is not that important of an indicator for private investors. This is more the prerogative of large, industrial investors, who conduct operations directly with government bonds. However, there is an important point here for online traders. The issue is that the bond market heavily influences the liquidity of currency, therefore the dependence of bond value on the interest rate is often used by professionals as a way to identify currency trends. Typically, there is a certain equilibrium, where the fall in bond profitability pulls the currency market down, as well as government bond growth leading to the increase of currency value. Therefore, by evaluating the pattern of interest rate influence on bonds, you can more accurately following possible movements in the currency market.


Stocks and Interest Rates

Interest rates affect the stock market more indirectly than they do bonds. Here we will soon need to consider the level of influence through the prism of economic factors. So, when the interest rate is rising, banks receive more profitable credit terms, forcing them to further raise their own rates for providing consumer credit to the wider population or business loans for enterprises. Therefore, in the first we see a decrease in consumer means, leading to a decrease in profits for businesses and producers, then production cost increases and the price of goods rises. In the end, these changes not only influence real economic indicators but effect, in practice, the activities of enterprises.

On that note, the increase or decrease of interest rates is a strong driver of stock market indicators. However, it is worth noting here that the market can react very quickly to changes in lending policies. So you can obtain projections of the influence of interest changes on the market long before those changes take place. This is a direct result of actions taken by specialists from large companies, who, like all other market participants, have preliminary information regards rate changes.

For example, you can encounter the price of specific goods rising. This is due to the company’s premature awareness of rate growth, leading them to take out cheaper loans earlier, then passing on the cost of this to the customer. This is visible in the stock price minimal decline of these issuers in comparison with companies that didn’t react in time to the news regarding interest rate changes. Therefore, by closely following the work of asset issuers, you can forecast the company’s future asset cost fluctuations.



Analyzing economic, financial indicators, as well as forecasting possible changes in the lending policies of governmental bodies should become more important as a priority for traders when conducting technical analysis. So as you can achieve stable and accurate trading indicators, and strive to conquer the financial Olympus.


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