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Tuesday, November 24, 2020

Compound Interest and Forex Trading

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There is no question that smart investors can profit from trading currency exchange pairs in the forex market, the most active and liquid financial marketplace in the world; however, you normally do not see compound interest being mentioned in forex trading discussion. Similar to equity securities and the bond markets, you can apply some of the principles of compound interest to your forex investment strategy and portfolio.

New Influences on the Foreign Exchange Market

The forex market has greatly expanded with the arrival of cryptocurrencies such as Bitcoin; moreover, now that China is rolling out a digital version of the yuan, you should expect to see traders and investors jumping into the forex market, which in turns more liquidity. The majority of forex traders engage in very active trading sessions, even more so than Wall Street day traders, and this is because the forex market runs around the clock. Most of these traders would not typically consider compound interest as part of their investing strategy; they think that the time value of money requires too much patience, and this something that they are not used to practicing when chasing fast pips as they jump from one currency pair to the next.

Compound interest can be applied to forex trading

Compound interest can be applied to forex trading in a couple of ways. Some brokers offer interest on certain currency pairs; the idea is to entice forex traders to hold a trade long enough to share some of the interest paid by sovereign bonds issued by the central banks of both currencies. You could actually derive more profit if you were able to obtain and hold the actual bonds, but you would also need to have enough cash to cover the face value purchase.

Compounding Interest with Forex Trading

The other way you can work the magic of compounding as a forex trader is to manage it on your own. Many forex brokers offer separate accounts for your capital and your portfolio; in some cases, the cash account will earn interest if the broker ties it to a money market instrument, and the interest might be simple or already compounded. To maximize the potential of your trading activity, you can use the profits you derive from the pips to deposit into your cash account.

In general, you will want your forex trading activity to generate more profit than your compound interest portfolio, but this is not something that many forex traders are able to achieve because of market volatility. For this reason, the more prudent approach of compound interest with conservative financial instruments can bring a sense of balance to your forex trading strategy.

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