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46-ICT Mentorship Core Content - Month 05 - Interest Rate Differentials

Last modified by Drunk Monkey on 2022-09-15 11:24
1 00:00:13,410 --> 00:00:20,640 ICT: Okay, folks, welcome back. This is lesson 2.3 was January 2017, RTT mentorship, we're looking at interest rate differentials.
2 00:00:25,740 --> 00:00:34,680 Okay, central bank interest rates, we're gonna be looking at a macro view, it really needs to start here. And there's several places on the internet, you can
3 00:00:34,680 --> 00:00:45,600 go to get this list, but this is the global currency, interest rates from the central banks. And this is the list that you can get from FX street.com. You do
4 00:00:45,600 --> 00:00:51,990 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
5 00:00:51,990 --> 00:01:00,060 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
6 00:01:00,060 --> 00:01:13,290 this list is from FX street.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
7 00:01:13,290 --> 00:01:25,500 the current state of the global economy, but generally, there's always going to be a higher interest rate among another currency versus another country. And
8 00:01:25,500 --> 00:01:34,650 basically, what you're going to do is, is you simply look for a currency or country in this case, that has a high interest rate. As you see here, the
9 00:01:34,650 --> 00:01:44,610 highest on this list is the Reserve Bank of New Zealand. The second in the high end of the interest rates would be the Reserve Bank of Australia. And obviously,
10 00:01:44,610 --> 00:01:56,850 the low end would be the Bank of Japan, and the Swiss bank and the European Central Bank at zero, we're gonna go through this in two passes. In other words,
11 00:01:56,850 --> 00:02:05,790 you want to find two trading examples on a higher timeframe basis, using interest rate differentials, starting with the interest rates, that are pegged
12 00:02:05,790 --> 00:02:06,960 at the central bank level.
13 00:02:14,430 --> 00:02:25,020 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, you can't get any more
14 00:02:25,020 --> 00:02:36,300 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
15 00:02:36,300 --> 00:02:48,870 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 a
16 00:02:49,380 --> 00:03:02,250 country's economy, you can see that in the form of a weak interest rate for that particular currency, or that country, Swiss National Bank, Bank of Japan,
17 00:03:03,480 --> 00:03:18,870 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.
18 00:03:20,460 --> 00:03:32,040 So if we were to take a look at these countries, we could build a model on a higher timeframe basis on long term macro trades, which have the most
19 00:03:32,370 --> 00:03:48,720 opportunity to move based on a fundamental establishment of interest rates being utilized for the selection process. But in other words, funds will seek to trade
20 00:03:48,870 --> 00:04:01,350 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
21 00:04:01,350 --> 00:04:10,890 they will look to sell against currencies and buy against strong currencies. In other words, they're gonna be buying strong pairs and selling weak pairs.
22 00:04:16,230 --> 00:04:26,940 Alright, 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
23 00:04:26,940 --> 00:04:34,860 to start the 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
24 00:04:34,860 --> 00:04:46,380 strong difference between the two interest rates. And obviously once you select the high end and the low end, currency or country, and this restricts your
25 00:04:46,380 --> 00:04:56,610 spective currency the obviously you're going to determine the forex pair coupling based on those two respective countries. For an example, we're going to
26 00:04:56,610 --> 00:05:05,640 assume that the Australian dollar is our selection for our high interest Rate yielding country. And the interest rate comes in at 1.5%. And we're going to
27 00:05:05,640 --> 00:05:19,170 pair that up with a weaker currency from the Federal Reserve, which is the US market with a point seven 5%, or three quarter point. Now, I'm gonna have to
28 00:05:19,200 --> 00:05:29,580 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 record the review, the
29 00:05:29,670 --> 00:05:41,490 Federal Reserve, central bank rate was at point five, zero. But when we look at this, that way, we couple that up for a forex pair, obviously, the Australian
30 00:05:41,490 --> 00:05:51,900 dollar pair is what we'll be looking at. Once we arrive at our currency that we're gonna be focusing on being a buyer of buying strength against a weaker
31 00:05:51,900 --> 00:06:01,560 currency, for instance, the dollar index here, we're gonna be looking for strong support on a higher timeframe chart. Now we're thinking long term macro
32 00:06:01,770 --> 00:06:14,670 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
33 00:06:14,670 --> 00:06:24,330 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
34 00:06:24,330 --> 00:06:35,880 coupling a pair based on a high yield interest rate 1.5% versus a half of 1% at the time of the trade, but in this case, we had to show the numbers as they are
35 00:06:35,880 --> 00:06:48,030 here now, point seven 5%. We wait for Smart Money clues that it's being bought. Now, we went through several of those things that indicates that in the
36 00:06:48,030 --> 00:06:59,070 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
37 00:06:59,070 --> 00:07:07,470 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're looking forward US
38 00:07:07,470 --> 00:07:10,860 Dollar Index directional confirmation that qualifies the setup.
39 00:07:16,709 --> 00:07:27,779 Okay, we're gonna look at the Australian dollar is the cash price for Australian dollar. And we identified a long term support level old low in the form of 7150.
40 00:07:31,469 --> 00:07:43,019 And we were 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
41 00:07:43,019 --> 00:07:51,269 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
42 00:07:51,269 --> 00:08:05,069 open interest. You see open interest has been declining. And notice this big reduction here, that purple line dropping like that that's a massive reduction
43 00:08:05,099 --> 00:08:17,729 in open interest. Open Interest is going to be a indication that there's short covering by way of the smart money or or large, commercial traders. If they're
44 00:08:17,729 --> 00:08:25,619 short covering, that means that they're not trying to assume the other side of the trade. For Buyers, they may want to reset themselves, because they
45 00:08:25,619 --> 00:08:35,789 anticipate what if they don't want to be short, we're anticipating sharply higher prices. And that's what you get here off that 7150. Now look at the look
46 00:08:35,789 --> 00:08:48,659 at the magnitude of the move seen with the Australian dollar here. Remember, the pair that we're trading in the forex market is Aussie dollar, all Z has that
47 00:08:48,659 --> 00:09:00,689 higher 1.5% interest rate. The Federal Reserve was offering point five zero to a latter part of December, where it was adjusted for another 25 basis point hike.
48 00:09:01,259 --> 00:09:11,609 So now it's at point seven 5%. For the Federal Reserve rate, it's still half of the interest rate that's yielding. When the Australian Central Bank, consider
49 00:09:11,609 --> 00:09:27,179 how much this pair has moved from 7150 level 400 Plus PIPs have been seen from this rally off of a higher timeframe support level 7150. Now, just because it
50 00:09:27,179 --> 00:09:35,339 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
51 00:09:35,339 --> 00:09:44,249 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
52 00:09:44,249 --> 00:09:57,689 money. And you couple the idea fundamentally that the higher yielding interest rate of 1.5% from the Australian central bank coupled against the weaker point
53 00:09:57,689 --> 00:10:10,229 seven 5% Or if you want to go back and use it Half a 1% rate. Either way, you're getting a higher yield off of the Australian currency versus the dollar. And
54 00:10:10,229 --> 00:10:19,589 that's why we've seen such a sharp rally and why I had been talking about the Australian dollar going higher as a basis of our teaching. Throughout this
55 00:10:19,589 --> 00:10:27,869 mentorship, we've been talking about the Australian dollar going higher, with respective levels that have just recently been hit with 7580 as that level that
56 00:10:27,869 --> 00:10:39,029 we just mentioned from last week. The fundamentals if you will, okay, we're aligned with the central bank interest rate of one and a half percent coupled
57 00:10:39,029 --> 00:10:50,189 against a weaker Federal Reserve point seven 5% interest rate for the dollar. When you have that basis, and you have technical to support it, and you're
58 00:10:50,189 --> 00:10:58,739 looking at a higher timeframe chart like this, it lines, your pockets with wonderful opportunities to continuously take large moves out of the marketplace,
59 00:10:58,739 --> 00:11:08,579 and you don't need to be trading a lot. But looking at these higher timeframe, interest rate yield scenarios, coupling it with high odds probability
60 00:11:08,579 --> 00:11:16,709 technicals, you get yourself in sync with the most significant price moves that are going to most likely surprise many of the neophyte traders.
61 00:11:22,530 --> 00:11:29,760 You can see also that we had a higher high in the dollar index when we failed to make a lower low in the Australian dollar.
62 00:11:35,250 --> 00:11:45,450 Okay, we're going to do another example where I select the payer with a low interest rate this time. And we're gonna select a country with a high interest
63 00:11:45,450 --> 00:11:58,470 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, point seven 5%,
64 00:11:59,370 --> 00:12:08,310 which again, that was actually half of 1%, at the time when this trade is being shown. So I had to adjust it and show you for your notes versus Japanese
65 00:12:09,060 --> 00:12:21,390 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.
66 00:12:25,590 --> 00:12:34,830 We're looking for strong resistance on higher timeframe charts. We're going to wait for Smart Money clues that it's being sold. In other words, we want to see
67 00:12:35,100 --> 00:12:46,380 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
68 00:12:46,380 --> 00:12:55,290 the trade and looking for Dollar Index directional confirmation to qualify the setup. So if we had the expectation that the weaker currency is the Japanese yen
69 00:12:56,010 --> 00:13:07,290 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 US Dollar versus
70 00:13:07,290 --> 00:13:18,300 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
71 00:13:18,300 --> 00:13:27,510 interest rate, that means that the pair we coupled for foreign exchange trading, the dollar yen is the pair would be trading so even though we're looking for
72 00:13:27,510 --> 00:13:37,350 weakness in yen, we're looking for the opposite of that for the pair to weights formed. So the dollar yen pair is actually going to strengthen or go up in our
73 00:13:37,350 --> 00:13:37,920 charts.
74 00:13:42,930 --> 00:14:00,780 As it relates to the cash, you can see the weekly chart here in a bearish order block at the 90 100 level right here and that was set the stage for a move and
75 00:14:00,780 --> 00:14:16,710 this is the cash price of the Japanese yen and price trades up into that 90 big figure. And weaknesses seen from that point on obviously, this is seen on the
76 00:14:16,710 --> 00:14:35,730 heels of the Donald Trump election. But nonetheless, this move many hundreds of pips well over 1200 pips of a price Moo. And again, it's based on the central
77 00:14:35,730 --> 00:14:48,480 bank interest rate and a differential between the two. And by having that coupled with strong technicals seasonal tendency, understanding that the market
78 00:14:48,480 --> 00:15:01,050 was expected high volatility because of the election. This massive decline seen in the cash price of Japanese yen is also seen in other Understanding because of
79 00:15:01,050 --> 00:15:13,260 our analysis or my 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
80 00:15:13,350 --> 00:15:22,260 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
81 00:15:22,260 --> 00:15:32,610 yen, and coupling that with the technicals that we teach or using the inner circle trader repertoire. It gives you these massive price moves based on a
82 00:15:32,610 --> 00:15:43,020 higher timeframe 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
83 00:15:43,020 --> 00:15:52,530 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 timeframe basis,
84 00:15:52,530 --> 00:16:01,530 because the large funds because of the nature of their trading style, their trend falling in nature, they're going to look at fundamental reasons to trade
85 00:16:01,590 --> 00:16:12,720 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
86 00:16:12,720 --> 00:16:23,100 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
87 00:16:23,100 --> 00:16:33,900 currency pairs. And having technicals aligned, you'll be able to see that footprint of large flows in funds, pouring money into a particular currency. If
88 00:16:33,900 --> 00:16:44,070 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
89 00:16:44,070 --> 00:16:52,890 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
90 00:16:52,890 --> 00:17:01,950 gonna talk about with interest rate differentials, and yield spreads. But for now, go through your charts and look at the interest rate differentials between
91 00:17:02,280 --> 00:17:11,730 all the weaker and higher yielding currencies on a central bank level. And look back over the last six months and see what pairs you see and find through as a
92 00:17:11,760 --> 00:17:20,130 homework assignment. Look for setups that took place, higher timeframe support resistance levels, institutional order flow ideas, open interest, try to
93 00:17:20,130 --> 00:17:30,360 incorporate that as well on support levels. And then justify why in hindsight, now, it's a good exercise, go back in hindsight, and justify why the
94 00:17:30,360 --> 00:17:38,490 fundamentals were in alignment with those significant price moves. And again, you're looking back three to six months for currency pair moves to take place.
95 00:17:38,610 --> 00:17:55,680 Now, I don't tell people or even advise people to trade exotic pairs. Now exotic pairs would be like Euro Swissy, okay, or something like that. But look at some
96 00:17:55,680 --> 00:18:05,340 of those currency pairs to have a higher yielding interest rate versus a lower interest rates, okay, and how you would pair them up in a forex pair and look at
97 00:18:05,340 --> 00:18:12,720 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
98 00:18:12,720 --> 00:18:25,650 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
99 00:18:25,680 --> 00:18:34,350 the funds would go in and move large scale in to a particular currency or out of a currency based on the interest rate information that we've covered here today.
100 00:18:34,890 --> 00:18:37,080 Till next time, I wish you good luck and good trading