If you think about it on a simple level, when you trade Forex, you are trading “cash”.
What is one of the things that is great about cash (apart from it buying you nice, shiny things)?
It’s that you can put the cash in a bank account and earn interest—your money makes you money. Sweet.
So, imagine you could earn a much greater amount of interest on your money if you open a bank account in another country.
Next, imagine if you could borrow money in your currency at a low interest rate, put it in the bank account in another currency, and earn at a higher rate. Sound good?
Now imagine that you can leverage this scenario, so that you could borrow 10, 50 or even 100 times the amount of money you have at a low interest rate, put it in your bank account in another currency, and earn the interest. Even better.
All of a sudden, we have what we know and love as leveraged spot Forex trading.
So how does this all relate to bonds?
Bonds’ tight relationship with currency
Bond markets allow us to track the fluctuations in interest rates. The higher the interest rate, the lower the value of the bond.
Big money follows these movements and, as you can imagine, there is a great deal of correlation between the price of the bond and the currency.
These correlations occur not just on the higher timeframes, but on the shorter-term ones too.
Two sides of the coin
It’s important to remember that when you are trading a currency pair, there are two sets of bonds you must follow, one for each currency in the pair.
What you are looking for is “divergence” between the prices of the two bonds. For example, if the interest rate is going down in Germany (meaning German Bunds are going up) and interest rates are rising in the US (meaning T-Notes are going down), then that would be the ideal scenario to be selling EUR and buying USD (short EURUSD).
So, make sure you keep an eye on bond prices for both of the currencies you are trading.
The intersection of bonds and currencies
The savy trader knows that when they are trading currencies, they are really trading a form of leveraged currency deposit.
The higher the interest rate, the more attractive the currency will be to own, and the lower it is, the more attractive it will be to short. Bonds provide us with a wonderful insight into this, in real time.
So why not play the game like a professional and watch bonds?
About the Author
Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders (get free access). He is the owner of www.fxrenew.com a provider of Forex signals from ex-bank and hedge fund traders (get a free trial). If you like Sam’s writing you can subscribe to his newsletter.