Why Is It Important To Understand Central Banks

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Let’s imagine a country is going to hike its rates next, but some economic data that the central bank watches changes, for example employment data or inflation, and the market feels that the hike is going to be delayed longer than they have originally anticipated, the currency is likely to weaken in the short term, but as the price falls the longer term investors are then likely to step in and drive the price back to its original direction again, because ultimately nothing has changed and there still will be a hike at some point, now another example is if a central bank is neutral.

They may feel that their currency is still too strong. So what will they do? They will publicly state their concern along with a threat to act if it continues, then all the upside movements on the currency will be much more limited in that case and the best way to trade it is to sell it.

And the final example is probably the one you are very familiar with, particularly after the financial crisis is if a central bank is conducting quantitative easing, so if they announce plans to expand the QE programme either in the short or long term, then that currency is very likely to depreciate, obviously, the exact opposite is true if they announce plans to reduce QE, the currency will then appreciate.

So if I was going to identify the biggest secret, although calling it a secret is not really accurate, I prefer to call it the single most important factor that has contributed to my profitability and also the profitability of all the other traders I work with, is understanding what the central banks are doing right now but also what they are planning to do in the future. If you can figure that out, then your trading will improve immeasurably.