The biggest factor influencing the foreign-exchange market is rate of interest changes made by any of the eight global central banks.
These changes are an indirect response to other economic indicators observed throughout the month, and that they can potentially move the market immediately and with full force. Because surprise rate changes often have the best impact on traders, understanding the way to predict and react to those volatile moves can cause higher profits. Forex markets track how different currency pairs’ exchange rates fluctuate.
One of the first factors that influence these exchange rates are relative differences in interest rates in each country.
While interest rates can often be predicted using economic models, news and surprise announcements can have immediate effects on rates that successively affect FX prices.
Interest rates are crucial to day traders within the forex market because the upper the speed of return, the more interest is accrued on currency invested, and therefore the higher the profit.
The risk of this strategy is fluctuation of currency, which can gravely offset any interest-bearing rewards. While you will always want to shop for currencies with higher interest (funding them with those of lower interest), such a move is not always wise.
Interest rates should be viewed with a wary eye, as should any news release about interest rates from central banks.