The fed has given all indications that it might raise interest rates later this year. 70% of Wall Street analysts interviewed by Wall Street journal believe that the tightening will come in September. 20% believe that the hike will come in November while 5% believe that the fed might delay the action to 2016. Traders should carefully follow the fed’s actions because of the importance of the action. You can be sure that the date the fed announces the hike, billions of dollars will be lost (and made). In this article, I will explore the implications of the hike and how day traders can position their trades to gain regardless the market reaction.
Reasons for a rate hike
While the economy is a complex machine, the fact is that credit and cash are the two biggest players. When you take a loan to build a house, you get a liability which becomes an asset to the contractor building your house. For this reason, interest rates determine how much people are going to borrow. Currently, the interest rate in America is almost zero which means that the cost of borrowing is very low. This has spurred a lot of borrowing by people who use the funds to buy assets or even normal items. In addition, the increased purchasing power has led to an increase in inflation which is not good for the economy. To ensure that this slows down, fed will be forced to increase the borrowing rate.
In 2008, the American economy faced a major recession resulting from the subprime mortgages. Many people lost their money and financial institutions such as Freddie Mac were forced to receivership. Many analysts believe that the existing interest environment was partly to blame.
How to position yourself
As stated above, billions of dollars will be made and lost too when the fed announces the rate hike. Unfortunately, nobody really knows when this will happen. In a recent interview, Janet Yellen, the Fed chair stated that they had resolved to prepare traders and investors in advance. This is good for traders.
The implications of not doing this could be the same as what happened in January when the Swiss National Bank (SNB) removed the peg on their currency. This resulted to massive losses for both individual and institutional traders. A number of hedge funds shut down. Brokerage Company, FXCM was forced to be bailed out. The announcement by Fed would have a similar implications to the market. As a trader, there are a number of things you can do to anticipate the move.
When such a policy decision is anticipated, the most important thing for you to do is to be informed. When you are informed, chances are lower that you will be caught off-guard. The best thing about this is that you don’t need a $200,000 per year Bloomberg subscription to get the information. It is readily available in all financial news sites and TV stations. You should be aware of the fed meetings. You should also take your time to read the fed minutes which are released a few days after the meeting happens.
After doing this, you should make your own independent analysis to make a good forecast. In their recent minutes, it was clear that the fed might delay the rate hike because of the uncertainties in Greece. At the time, China’s economy was doing very well. Now, things have changed and the volatility from Greece has reduced while China’s stock market has taken a dive. As a trader, its important to read between the lines and make an independent analysis.
In addition, you should have a look at the American data. The fed stated that they would tighten only when the data was positive. If the data released continues to be positive, you can be sure that the action is around the corner. On the other hand, if the data disappoints, you can be sure that the tightening could take time.
At such a trading environment, its important for you to use a stop loss in every trade that you make. A stop loss stops a trade automatically when it reaches a predetermined point. As stated above, the implications of a rate hike in the United States will have very significant implications and billions will be lost. A well calculated stop loss will help you reduce the risks of losing everything.