ICT Mentorship Core Content - Month 05 - Interest Rate Differentials
Summary
TLDRThis lesson from the January 2017 ICT mentorship focuses on interest rate differentials as a fundamental basis for currency trading. It discusses how higher yielding currencies are bought against weaker ones, using the Reserve Bank of New Zealand and the Federal Reserve as examples. The importance of aligning with central bank interest rates and using technical indicators like support levels and open interest is emphasized for long-term macro trades.
Takeaways
- 📈 Interest Rate Differentials: The script emphasizes the importance of looking at central bank interest rates to identify currency pairs with a significant interest rate difference for potential trading opportunities.
- 🌐 Global Currency Interest Rates: It suggests using resources like fxstreet.com to obtain a list of global currency interest rates, which can be a starting point for macroeconomic analysis.
- 🏦 Central Banks as Fundamentals: The script highlights that interest rates set by central banks are a fundamental basis for buying or selling a currency, indicating the strength or weakness of an economy.
- 🔑 High Yielding Currencies: It points out that funds tend to seek high-yielding currencies like the Australian or New Zealand dollar, which offer higher interest rates compared to others.
- 📉 Low Yielding Currencies: The script identifies low-interest-rate currencies such as the Japanese yen, Swiss Franc, and the Euro, which may indicate economic weakness or lower potential returns.
- 🤑 Money Seeks Yield: The concept that capital naturally moves towards higher yields is used to justify buying strong currencies and selling weaker ones.
- 📊 Technical Analysis: The script mentions the importance of using technical analysis tools like support and resistance levels, seasonal tendencies, and open interest to confirm trading setups.
- 📈📉 Forex Pair Selection: It explains how to select a forex pair for trading by coupling a high-interest-rate currency with a low-interest-rate currency, such as the Australian dollar with the US dollar.
- 📚 Smart Money Clues: The script advises looking for 'smart money' indicators such as significant changes in open interest, which can signal large-scale trading activity by institutional investors.
- 🌟 Long-Term Perspective: It stresses the use of a long-term macro perspective for trading, focusing on fundamental reasons and technical confirmations for significant price movements.
- 🚫 Avoid Exotic Pairs: The script advises against trading exotic currency pairs due to their higher risk and recommends focusing on major currency pairs with clear interest rate differentials.
Q & A
What is the main focus of Lesson 2.3 in the January 2017 ICT mentorship?
-The main focus of Lesson 2.3 is on interest rate differentials and how they relate to central bank interest rates, and their impact on global currency trading.
Where can one find a list of global currency interest rates from central banks?
-A list of global currency interest rates can be found on websites like fxstreet.com, which is mentioned in the script as a source.
Why are central bank interest rates considered fundamental in macroeconomic trading?
-Central bank interest rates are fundamental in macroeconomic trading because they directly influence the attractiveness of a currency for investment, with higher interest rates often leading to increased demand for that currency.
What is the significance of the Reserve Bank of New Zealand's interest rate in the context of the script?
-The Reserve Bank of New Zealand's interest rate is highlighted as the highest among the listed central banks, making its currency potentially attractive for yield-seeking investors.
Why would a trader consider the interest rate differential between the Reserve Bank of Australia and the Bank of Japan?
-A trader would consider the interest rate differential to identify potential trading opportunities, as the higher interest rate of the Reserve Bank of Australia compared to the Bank of Japan could indicate a stronger currency performance.
What does the script suggest about the Bank of Japan's and the Swiss National Bank's interest rates?
-The script suggests that the Bank of Japan and the Swiss National Bank have lower interest rates, which could indicate a weaker currency and potentially less attractive investment opportunities compared to higher interest rate currencies.
How does the script relate interest rate differentials to the selection of forex pairs for trading?
-The script relates interest rate differentials to forex pair selection by suggesting that traders should look for a currency with a high interest rate to pair with one with a low interest rate, aiming to buy the high-yielding currency and sell the low-yielding one.
What is the role of 'smart money clues' in confirming a trading setup according to the script?
-Smart money clues, such as seasonal tendencies or changes in open interest, are used to confirm a trading setup, indicating that large commercial traders are taking positions that align with the fundamental interest rate differential analysis.
Can the interest rate differentials be used for short-term trading strategies as suggested in the script?
-The script suggests that interest rate differentials are more applicable to long-term macro trades rather than short-term strategies, as they are more indicative of large fund movements and fundamental economic trends.
What does the script imply about the importance of technical analysis in conjunction with interest rate differentials?
-The script implies that technical analysis, such as identifying support and resistance levels, is crucial in conjunction with interest rate differentials to time entries and exits in trades effectively.
How does the script use the Australian Dollar and the Japanese Yen as examples for trading based on interest rate differentials?
-The script uses the Australian Dollar as an example of a high-yielding currency to buy and the Japanese Yen as an example of a low-yielding currency to sell against, illustrating how interest rate differentials can influence currency pair movements.
Outlines
📈 Introduction to Interest Rate Differentials in Forex Trading
The script begins with an introduction to Lesson 2.3 of the January 2017 ICT mentorship, focusing on interest rate differentials and their impact on currency trading. It emphasizes the importance of starting with an understanding of central bank interest rates as a fundamental basis for currency selection. The speaker provides guidance on where to find a list of global currency interest rates and suggests that these rates are a crucial starting point for macroeconomic analysis. The lesson outlines the process of identifying high and low interest rate currencies and suggests that traders should consider buying high-yielding currencies and selling low-yielding ones, using the Reserve Bank of New Zealand and the Reserve Bank of Australia as examples of high-interest rate currencies, and the Bank of Japan and the Swiss National Bank as examples of the opposite. The speaker also mentions that the information provided in the notes will be rich with details on where to obtain and how to use this information.
🔍 Selecting Forex Pairs Based on Interest Rate Differentials
This paragraph delves into the practical application of interest rate differentials in selecting forex pairs for trading. The speaker illustrates how to pair a high-interest rate currency, such as the Australian dollar with an interest rate of 1.5%, with a lower-interest rate currency from the Federal Reserve, which at the time had a rate of 0.75%. The importance of considering the central bank rates as a fundamental basis for buying or selling a currency is highlighted. The speaker also discusses the use of smart money clues, such as seasonal tendencies and open interest, to confirm trading setups. An example is given where the Australian dollar, with its higher interest rate, is bought against the US dollar, particularly when the US dollar index shows signs of weakness and there is a significant reduction in open interest, indicating short covering by large traders.
📊 Utilizing Interest Rate Differentials for Long-Term Trading Strategies
The speaker continues with the theme of interest rate differentials, this time focusing on how they can be used to identify long-term trading opportunities. The paragraph explains how a higher yielding currency, such as the US dollar with an interest rate of 0.75% (adjusted from 0.50% after a rate hike), can be paired against a lower yielding currency like the Japanese yen, which at the time had a negative interest rate. The speaker uses the example of the USD/JPY pair, discussing how to look for strong resistance levels on higher time frame charts and waiting for smart money clues that indicate a sell-off. The importance of aligning with central bank interest rates and using technical analysis to confirm trade setups is emphasized, with the speaker providing an example of a significant price move in the USD/JPY pair following a resistance level break and a sharp decline in open interest.
🌐 Conclusion on the Role of Interest Rate Differentials in Currency Trading
In the final paragraph, the speaker wraps up the lesson by summarizing the importance of interest rate differentials in currency trading and how they can be used to identify significant price moves. The speaker encourages traders to review charts and analyze interest rate differentials between currencies, especially over the last six months, to understand the impact on currency pair movements. The paragraph also touches on the idea of yield spreads and their role in swing trading, suggesting that these concepts will be discussed in more detail in future lessons. The speaker advises against trading exotic pairs due to their inherent risks but encourages traders to look at the interest rate information from a central bank level and consider how it aligns with price action to identify potential trading opportunities.
Mindmap
Keywords
💡Interest Rate Differentials
💡Central Bank Interest Rates
💡Macro View
💡FXStreet.com
💡Yield
💡Forex Pair
💡Smart Money
💡Open Interest
💡Support and Resistance Levels
💡Long-Term Macro Trades
💡Dollar Index
Highlights
Introduction to Lesson 2.3 of the January 2017 ICT mentorship focusing on interest rate differentials.
Importance of starting with a macro view and central bank interest rates for fundamental trading decisions.
Use of global currency interest rates from central banks as a basis for trading decisions.
The mention of fxstreet.com as a source for the list of global currency interest rates.
Explanation of how to use the list of interest rates to identify high and low yielding currencies for trading.
Identification of the Reserve Bank of New Zealand and Australia as having the highest interest rates.
Identification of the Bank of Japan and Swiss Bank as having the lowest interest rates.
Discussion on the fundamental basis for buying or selling a particular currency based on interest rates.
The concept of money seeking yield and its relation to high interest rate currencies.
The strategy of trading high yielding currencies against weak yielding ones.
Example of selecting a trading pair based on interest rate differentials, such as Australian Dollar and US Dollar.
Importance of technical analysis in conjunction with interest rate differentials for trading decisions.
Use of smart money clues like seasonal tendencies and open interest to confirm trading setups.
Analysis of the Australian Dollar's movement based on its high interest rate and support levels.
Explanation of the significant price move of the Australian Dollar after a reduction in open interest.
Strategy of looking for currency pairs with high and low interest rates for potential trades.
Case study of the US Dollar versus Japanese Yen pair and its movement based on interest rate differentials.
Discussion on the practical application of interest rate differentials in long-term macro trading.
Emphasis on using interest rate differentials with technical analysis for high probability trades.
Encouragement to analyze charts and interest rate differentials for the last six months to identify significant currency pair moves.
Advice on not trading exotic pairs but understanding the interest rate differentials for educational purposes.
Final thoughts on the simplicity and effectiveness of using central bank interest rates for fundamental trading strategies.
Transcripts
okay folks welcome back this is lesson
2.3 of the january 2017 ict mentorship
we're looking at interest rate
differentials
okay central bank interest rates
if we're going to be looking at a macro
view it really needs to start here
and there's several places on the
internet you can go to get this list but
this is the global
currency
interest rates from the central banks
this is the list you can get from
fxstreet.com
you do a simple google search and in the
notes for the pdf i'll have all the
links for all these things
even though they don't show up in the
actual presentations in your pdf file
like i said the notes will be rich with
details about where to get the
information from and what you can do
with it
but this list is from
fxstreet.com
and
what you want to do is
when you look at the list and obviously
it's a rather anemic
list of interest rates currently in the
current state of uh
the global economy
but generally there's always going to be
a
higher interest rate among another
currency versus another
country
and basically what you're going to do is
you simply look for
a currency or country in this case
that has a high interest rate
as you see here the highest on this list
is the reserve bank of new zealand
the second in the
high end of the interest rates would be
reserve bank of australia
and obviously the low end would be the
bank of japan
and the swiss bank
and
the european central bank at zero we're
going to go through this in
two passes in other words we're going to
find two trading examples on a higher
time frame basis using interest rate
differentials
starting with the interest rates that
are pegged at the central bank level
now again if we're looking at this this
is going to cut to what fundamental
basis there is to buy or sell a
particular currency
uh you can't get any more fundamental
than interest rates so
if we're going to look at these
countries
if we pick for instance
a currency that we want to be a buyer of
obviously money seeks yield so it makes
perfect sense to be a buyer of
australian
or new zealand currency
if you're expecting weakness in a
particular country or in a
country's economy
you can see that in the form of a weak
interest rate
for that particular currency or that
country
uh swiss national bank
bank of japan
european central bank
bank of canada
bank of england
even federal reserve really it's very
low end
on the interest rate curve
based on this list here
so if we were to
take a look at these countries
we could build a model on a higher time
frame basis
on long-term macro trades which have the
most opportunity to move
based on a fundamental
establishment of
interest rates being utilized for
the selection process
put in other words
funds will seek to trade high yielding
currencies
and place that
against a weak yielding currency
and they will look to buy strong
currencies and sell against weak
currencies and they will look to sell
against currencies and buy against
strong currencies in other words they're
going to be buying strong payers and
selling weak pairs
all right let's take a look at selecting
a pair for trading
first thing you do is you want to look
for a country that has a high interest
rate
then you want to select a country with a
low interest rate
it doesn't have to be the lowest of the
low it doesn't have to be the highest of
the high it can be just a very strong
difference between the two
interest rates
and then obviously once you select the
high end and the low end currency
or country in this respective currency
obviously
you're going to determine the forex pair
coupling based on those two
respective countries
for an example we're going to assume
that the australian dollar is our
selection for our high interest rate
yielding country
and the interest rate comes in at 1.5
percent
and we're going to pair that up with a
weaker currency from the federal reserve
which is the u.s market
with a 0.75 percent or three-quarter
point
now i'm going to have to remind you that
this data is
factored in with a interest rate hike of
25 basis points so
at the time of the trade we're going to
actually review the federal reserve
central bank rate was at 0.50
but when we look at this the way we
couple that up for a 4x pair
obviously the australian dollar
pair is what we'd be looking at
once we arrive at our currency that
we're going to be focusing on being a
buyer of buying strength against a
weaker currency for instance the dollar
index here
we're looking for strong support on a
higher time frame chart now we're
thinking long-term macro perspective
so we're only looking for
large moves in a fund level trend
following idea but before we get to that
point we have to expect
some sizable move that's going to be
positioned with
big flows behind it
again we're fundamentally aligning
ourselves with the central bank interest
rates
we're coupling a pair based on a high
yield interest rate 1.5 percent
versus a
half of one percent at the time of the
trade but in this case we have to show
the numbers as they are here now uh 0.75
percent
we wait for smart money clues that it's
being bought now we went through several
of those things that indicates that in
the mentorship so far
but we'll revisit a few of them for this
example
seasonal tendency and or open interest
can confirm this
so there's our two elements of smart
money tools that we can use it doesn't
have to use every possible scenario we
only need one or two to confirm
and we are looking for us dollar index
directional confirmation that qualifies
the setup
okay we're going to look at the
australian dollar
this is the cash price for australian
dollar
and we identified a long-term support
level old low in the form of 71.50
and we move over to our
march contract 2017 of australian dollar
which would be the active contract that
you would be trading at the end of
december 2016.
we're going to add that 7150 level on
our chart you can see price has traded
into that as support
now i want you to take a closer look at
what's going on with open interest
as you see open interest has been
declining
and notice this big reduction here
that purple line dropping like that
that's a massive reduction in open
interest open interest
is going to be a
indication that there's short covering
by way of the smart money or large
commercial traders
if they're short covering
that means that they're not trying to
assume the other side of the trade for
buyers they want to reset themselves
because they anticipate what if they
don't want to be short they're
anticipating sharply higher prices
and that's what you get here off that
71.50 now look at the look at the
magnitude of the move
seen
with the australian dollar here
remember the payer that we're trading in
the forex market is aussie dollar all z
has
that higher 1.5 interest rate
the federal reserve was offering 0.50
to the latter part of december where it
was adjusted for another 25 basis point
pike
so now it's
at 0.75 percent for the federal reserve
rate it's still
half of the interest rate that's
yielding
on the australian central bank consider
how much this pair has moved
from the 71.50 level
400 plus pips have been
seen from this rally
off of a higher time frame support level
71.50 now just because it trades in a
higher time frame support level
doesn't mean that it's going to trade
higher
but when you couple that 7150 level
which is a higher time support level or
an old low
and you also notice that the market has
seen a sudden reduction in open interest
which is short covering on the part of
smart money
and you couple the idea fundamentally
that the higher yielding interest rate
of 1.5 percent from the australian
central bank
coupled against the weaker
0.75 percent or if you want to go back
and use the half of one percent rate
either way
you're getting
a higher yield off of the australian
currency
versus the
dollar
and that's why we've seen such a sharp
rally and why i have been talking about
the australian dollar going higher as a
basis of our teaching
throughout this mentorship we've been
talking about the australian dollar
going higher
with respective levels that have just
recently been hit with 75 80 as that
level that we just mentioned from last
week
the fundamentals if you will
okay were
aligned with the central bank interest
rate of one and a half percent coupled
against a weaker federal reserve
0.75
interest rate for the dollar when you
have that basis and you have technicals
to support it and you're looking at a
hard time frame chart like this it lines
your pockets with wonderful
opportunities to continuously take large
moves out of the marketplace and you
don't need to be trading a lot
by looking at these higher time frame
interest rate yield scenarios
coupling it with high odds probability
technicals you get yourself in sync with
the most significant price moves to are
going to most likely surprise many of
the neophyte traders
you can see also that we had a higher
high in the dollar index
when we fail to make a lower low in the
australian dollar
okay we're going to do another example
we're going to select a pair with a low
interest rate this time
and we're going to select a country with
a high interest rate
and we're going to determine the forex
pair that couples for that trade
in this example we're going to use a
higher yielding currency
0.75 percent
which again that was actually
half of one percent of the time when
this trade is being shown so i have to
adjust it show you for your notes
versus japanese uh economy and their
central bank rate was
negative
and the two respective
countries and their currencies would be
paired up in the form of
dollar yen
we're going to look for strong
resistance on higher time frame charts
we're going to wait for smart money
clues that it's being sold in other
words we want to see japanese yen hit
resistance levels and show indications
that it wants to sell off
and we're looking for seasonal
tendencies and or open interest to
confirm the trade
and looking for dollar index directional
confirmation to qualify the up so if we
have the expectation that the weaker
currency is the japanese yen
interest rate basis
against the stronger of the two
the dollar
which has the higher yielding central
bank rate
we're going to see that u.s dollar
versus japanese yen
pair
actually go higher
because you're buying dollar and selling
in so if we're expecting weaker japanese
yen because of the weaker lower interest
rate
that means that the pair we coupled for
foreign exchange trading
the dollar yen is the pair we'll be
trading so even though we're looking for
weakness in yen
we're looking for the opposite of that
for the pair the way it's formed so the
dollar yen pair is actually going to
strengthen or go up in our charts
as it relates to
the cash
you can see the weekly chart here
and a bearish order block
at the 9800 level
right here
and that would set the stage for a move
this is the cash price of the japanese
yen
and price trades up into that 90 big
figure
and weakness is seen from that point one
obviously
this is seen on the heels of the donald
trump election
but nonetheless this move
many hundreds of pips
well over 1200 pips of a price move
and again
it's based on
the
central bank interest rate
and the differential between the two
and by having that coupled
with strong technicals
seasonal tendency
understanding that the market was
expected high volatility because of the
election
this massive decline
seen in the cash price of japanese yen
is also
seen in the understanding because of our
analysis or my own analysis as we were
going through the mentorship
why i was calling the dollar yen higher
all those factors for
leading us up into
those
commentaries
this was the basis behind it all having
the higher yielding interest rate of the
dollar versus the weaker currency
interest rate of the yen
and coupling that with
the technicals that we teach or use in
the inner circle trader
repertoire
it gives you these massive price moves
based on a higher time frame premise
so you're using these things again
you're not using them to day trade
you're not using them to facilitate
short-term trades but if you trade in
that direction obviously your trades
will be a lot higher probability but
they're more inclined to
be used on a higher time frame basis
because
the large funds because of the nature of
their trading style their trend filing
in nature
they're going to look at fundamental
reasons to trade specific currencies
and if you look at the moves that's
transpired in the last three to six
months
all of the big moves come by way of the
information that's drawn by the
differentials that we've discussed so
far here and the method of using those
central bank interest rates
pegging them together to get
specific currency pairs
and having technicals align you'll be
able to see that footprint of large
flows and funds pouring money into a
particular currency
if you look at the
dollar yen pair in relationship to this
in november you would see a strong buy
or a low in that particular currency
pair
so we're going to talk more about
differentials we're actually going to
start talking about
yield spreads also when we get into
swing trading so there's other
information we're going to talk about
with interest rate differentials
and yield spreads but for now
go through your charts and look at the
interest rate differentials between
all the weaker and higher yielding
currencies on the central bank level and
look back over the last six months and
see what payers you see
and find through as a homework
excitement look for setups that took
place higher timeframe support
resistance levels institutional order
flow ideas open interests try to
incorporate that as well on support
levels
and then
justify why
in hindsight now this is a good exercise
go back in hindsight and justify why the
fundamentals were an alignment with
those significant price moves and again
you're looking back three to six months
for currency pair moves to take place
now i don't
tell people or even advise people to
trade
exotic pairs now exotic pairs would be
like uh
euro swissy okay or something like that
but
look at some of those currency pairs to
have a higher yielding interest rate
versus a lower interest rate okay and
how you would pair them up in a forex
pair and look at the respective price
action in the last three to six months
on those pairs
viewing the the information that we're
using from the central bank level at the
interest rate
again
this is a really simplistic approach to
trading long term
and it's coupled with
dare i say it again a fundamental
application of how the funds would go in
and move large scale
into a particular currency or out of a
currency based on the interest rate
information that we've covered here
today until next time i wish you good
luck and good trading
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