Why Having an Effective Trading Strategy is Important
Participating in forex trading presents an opportunity to take part in a global marketplace with significant potential. Due to its popularity with day traders, forex has even gained a reputation for turning quick profits. In truth, it’s just as complex and competitive as any other world marketplace. To not only succeed but also succeed consistently, you need to understand the market and hone your trading strategy.
There are a variety of ways to trade forex, so it’s important to choose an approach that is well-suited to your experience level, your goals, and the context in question. Below, we’ve outlined the basics, benefits, and drawbacks of nine popular forex trading strategies to help you find your ideal fit.
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If you’re a casual trader currently improving your forex awareness and looking for ways to boost your output through new skills and strategies, then you’ve come to the right place. There are a number of different economic reports and indicators put out throughout the year, and each can have a very significant impact on your forex trading efforts. In this guide, you’ll find clear definitions of the 10 leading economic indicators, as well as information on how they affect the forex market.
U.S. Non-Farm Payrolls (NFP)
Released on the first Friday of every month, this indicator is one of the most important reports on the calendar for a lot of forex traders. U.S. Non-Farm Payrolls are released in line with the Employment Situation Report by the Bureau of Labor Statistics (BLS), so this report has a lot of power behind it. One reason for this is the timing of the report, because the business cycle and employment levels are closely related. Historically, any changes in the non-farm payrolls have moved very closely with quarterly GDP changes, meaning that, essentially, non-farm payrolls can be used as a sort of proxy for the GDP. The main difference between the GDP and non-farm payrolls is that the latter are released on a monthly basis, while the former comes out only quarterly and typically with a delay.
Another reason that this report is so popular among traders is the fact that it has a lot of impact on monetary policy, which makes it more or less impossible to ignore. There is a dual mandate with two key goals that the Federal Reserve keeps in mind: stable prices and maximum employment. As a result, employment data has a substantial effect on perceptions about the market and the future of monetary policy in general
U.S. Federal Interest Rates
Another huge influence on the foreign exchange market are any changes in interest rates that are made by one or more of the eight major central banks around the globe. These changes are responses, albeit indirect ones, to other economic indicators that appear throughout the month. The one thing that these reports have that is so important is the ability to change the market suddenly and drastically, potentially sending shockwaves toward any forex trader. It’s important that traders understand and learn how to react—and even predict—these incredibly volatile moves, as doing so can make surprise rate changes lead to higher profits, and at a minimum, dampen any potential portfolio damage.
The reason that U.S. federal interest rates are so critical when it comes to forex traders is simple: More interest applied on a higher rate of return equals more profit. There is a risk to this strategy, though, primarily in the fluctuation of currency, which can be very dramatic and offset any rewards you may get from interest. It’s not always wise to buy high-interest currency with low-interest currency, nor is it that easy, either.
US Federal Funds Rate
The Federal Open Markets Committee (FOMC) holds their meetings eight times a year to determine the monetary policy of the United States. If there is any deviation from what’s expected by market analysts, the outcomes of these meetings can drastically affect the forex market. One of the most important things when it comes to forex rates is the interest rate level of the currencies involved, as well as the expectations of those interest rates. If the FOMC makes any change to the rate of the federal funds, it can make a significant difference to the value of the USD.
After every FOMC meeting, a statement is released that offers guidance about the expected path of monetary policy, which should help forex traders steer the course better. A fairly recent development, this statement is released partially in order to reduce volatility in markets such as forex, as well as to provide greater transparency overall. However, this guidance also has a lot of force behind it to move markets, just as if it were an actual policy change, making it at times resemble a double-edged sword.
Gross Domestic Product (GDP)
The Gross Domestic Product report (GDP) is a wide measure of the ultimate and overall economic health of any particular nation. In actuality, this report tends to come out muted—as in, it doesn’t have much of an effect on the forex market, because by the time it comes out, a good portion of its components are already public, resulting in reasonably accurate expectations. However, it is important to note that divergences on this report can still move the market massively, despite its timing.
Ultimately, the GDP is one of the most important indicators for any forex trader to pay attention to, because it lets you know where you stand in the business cycle. In economics in this day and age, understanding the business cycle is key. It has two phases: expansionary, where the economy grows in many areas simultaneously, and recessionary, where the economy contracts in many areas simultaneously. The GDP is the widest measure of the economy and its activity, and so economists determine where in the business cycle we stand by studying growth and contraction in the report. A recession is technically defined by two consecutive quarters of contraction, and it ends as soon as we see a quarter of growth in the GDP.
Economic analysts—as well as politicians and policy-makers—heavily focus on this indicator, largely because it is so comprehensive. The GDP is vital to investment banks that take a top-down approach to analyzing the forex market’s macroeconomics.
Consumer Confidence Index
Technically, this takes the form of two reports: the Consumer Confidence Index (CCI) by the Conference Board, and the Consumer Sentiment Index by the University of Michigan. Though many consumer questionnaires exist, these two reports are arguably the most well-known and easily the most followed by traders and economists alike. The same thing that pushes forward the American economy at its core—active consumer spending—drives these two reports. Consumer confidence gives traders insight into how consumers feel. For example, if they feel safe in their employment and ultimately good about their short-term future finances and economics, they are logically more likely to go and spend more money, which drives economic growth. On the other hand, consumers that aren’t confident in their jobs and economic futures won’t go out and spend. Either way, pessimistic or optimistic, consumer confidence has a strong effect on the economy.
The CCI is released at the close of every month, while the Consumer Sentiment Index is released twice a month. What this essentially means is that there is a preliminary finding on the last Friday of the month, and then the last estimate at the end of the month. These two reports have an especially lasting impact when the business cycle is in the midst of or close to a turning point. Customer sentiment and confidence can signal a bullish upturn or a bearish downturn.
Consumer Confidence Indexes are common in many other economies too, like the Eurozone, UK and Australia. These will move the currencies of the economy either positively or negatively depending on the strength of each months reading.
Consumer Price Index (CPI)
The Consumer Price Index (CPI) is a report that measures the current cost of goods and services, offering insight into how quickly prices are falling and rising, or leaning into price stability. Inflation that is considered normal falls within a target range, but if inflation diverges for too long, it can impact the economy in a significantly negative way. The CPI is the preferred report for forex traders, as it is reported more often than the economist-preferred report in the PCE.
In all honesty, the CPI is limited when it comes to usefulness as an indicator of the economy; It has proven time and again that it is a poor indicator of business cycles. This is all in spite of a logical correlation between demand, economic growth, and raised prices. Inflation was a huge problem in the late 1970s and early 1980s for the United States. Then, as a fallout of the global financial crisis, there was the danger of prolonged price decreases, or deflation, which hurts the economy by encouraging consumers to buy when prices will inevitably become cheaper in the future (given that the price continues to fall). This ultimately creates a venomous cycle of slowing economic growth.
Despite its flaws, the CPI has a profound impact on the forex and stock markets. Just like a multitude of other reports, it is deviation from the expected that has the greatest effect. If, for example, the CPI comes in higher than previously expected, it will give the impression that monetary policy will be tightened in the near future, resulting in a bullish market for the U.S. dollar.
Purchasing Managers Index (PMI)
An indication of the health of the economy, specifically in the manufacturing sector, the PMI is comprised of five indicators in total: employment environment, production, new orders, inventory levels, and supplier deliveries. Its purpose is simply to offer insight into business world conditions to people such as analysts, purchasing managers, and decision makers for companies.
The information is gathered through surveys sent monthly to about 300 companies, and is then generated by the Institute of Supply Management on a monthly basis. PMI readings of greater than 50 imply growth in the manufacturing sector, while a reading that remains at 50 indicates no growth, with a lower figure being self-explanatory. The PMI is sometimes referred to as the ISM index and should be closely followed by active forex traders.
Industrial Production Index (IPI)
The U.S. output, measured in quantity of material produced, is measured monthly in the Federal Reserve’s report, the Industrial Production Index. It’s based on a three wide areas: manufacturing, electric and gas utilities, and mining. Some of the report is based on hard data reported directly from certain industries, but this isn’t always the case due to data availability.
There are literally hundreds of components to this index, which are then compiled and reported as a level of the index. For example, May 2017’s index level was 105.0. It is expressed as the current output against a base year, which, at time of writing, is 2007. Therefore, the May 2017 output levels were 5 percent higher than the average level of 2007.
Though manufacturing is a sector that only makes up approximately 20 percent of the U.S. economy, because it is responsible for a huge amount of change in the United States’ output, forex traders closely watch it. In addition, it is considered pro-cyclical, meaning that there is a correlation between the movements of the index and that of the business cycle. Some analysts even use this report as an early indicator of the GDP.
Retail Sales Data
Known to traders by the simple name of “retail sales,” the full name of this report is “Advance Monthly Sales for Retail Trade.” The Census Bureau releases it halfway into the month it is reporting on at precisely 8:30 a.m. EST. The number in this report is nominal dollar value, meaning that it is not tuned for inflation. The report offers a percentage change from the previous month, as well. Traders are typically more interested in the second figure, due to its impact on market prices—especially, as usual, in the case of divergences between the report and expectations.
Typically, retail sales that increase in the report indicate strong economic health and the forex market will see a bullish upturn, but there are considerations for inflation. An increase in retail sales might positively affects the dollar, but negatively impacts the bond price while retail sales that are weak will likely have a negative effect on the market and the U.S. dollar.
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Rate of Inflation
One thing that has a huge impact on a country’s currency and its foreign exchange rate is the rate of inflation within the country in question. However, it’s important to note that inflation isn’t the end-all, be-all of factors—it’s one of many. Inflation is much more likely to negatively affect a currency’s value and exchange rate. Low rates of inflation do not mean that exchange rates for that country are favorable, but by the same token, high inflation rates are likely to negatively impact that country’s exchange rates.
Inflation and interest rates are very closely related, and the pair can influence exchange rates. Countries try to delicately balance interest rates with inflation rates, but the relationship between the two is very complex and difficult to manage. Low interest rates encourage consumer spending, but do not bring in foreign investment while higher interest rates discourage consumer spending, but do bring in foreign investment. The bottom line is that many times, interest rates can be a double-edged sword.
These may be 10 of the highest impact economic releases but there are literally hundreds each month released by all global economies that can affect foreign exchange rates. The impact from these economic events can be immediate, such as when a sudden move in forex rates comes out significantly different from the expected consensus. Regardless of what type of trader you are, you should always keep a close eye on the economic releases using an economic calendar.