There is a big misconception among retail traders that economic indicators are dangerous. In fact, some avoid this approach at all costs. This shows a lack of understanding. The truth is that professional traders actively prepare for and trade these economic indicators each month. That’s the purpose of this article: to show you how to trade economic indicators.
What are economic indicators?
Economic indicators are simply sets of data about the economic performance of a country or region. They are typically released monthly or quarterly – and are often the focus of the financial markets.
But how does a trader profit from economic indicators? Well, to do this you need to understand the concept of fundamental analysis. Remember, this is the strategy used by professional Forex traders. If you’re not familiar with fundamental analysis, I suggest you read this article.
Why are economic indicators important?
In a nutshell, economic indicators are important because central banks watch them closely. Specifically, central banks use these indicators to see how their economy is performing. Moreover, they use the data from these indicators to spot developing trends they might need to address. These trends include levels of unemployment and the rate of inflation.
To address trends, the central bank can employ monetary policy tools – such as increasing interest rates or undertaking a programme of quantitative easing. For example, quantitative easing is usually used to kick-start economic growth and employment.
These actions cause currency prices to form long-term trends, one way or the other, depending on what the central bank does.
This makes the markets very interested in the central banks. Because central banks and the markets are watching each other, economic indicators have the potential to create large moves. Traders are always trying to get into the market before these large moves occur. So you can expect price moves to occur when an economic indicator suggests potential central bank action.
How to trade economic indicators
As a general rule there are two main ways to trade economic indicators.
The first way is to trade into them. This means that you check an economic calendar each week and note how the expected release relates to previous data. The calendar provides all of this information.
For example, if this month’s number is expected to show an improvement on the number from last month, then this could be considered positive. In this scenario, it is likely that the market will start buying the related currency ahead of the data actually being released.
The caveat to this is that the expected move should be in line with the prevailing mood of the markets. In the example above, you would need the market to be positive about the currency in question. If you do not trade in line with the mood of the market then you will get caught out. Remember, understanding the mood of the market is all part of having a solid understanding of the fundamentals.
An alternative method
The second way to trade economic indicators is to trade out of them.
This involves placing a trade after the data’s publication. You can then compare this to what the market was expecting. If there is a deviation between the two, then there is a trading opportunity.
For example, if this month’s number is forecast to show an improvement on the number from last month, this is positive. In this scenario, it is likely that the market will start buying the related currency ahead of the data’s publication.
The market always reacts to surprising data. In fact, the less expected something is the more sustained the resulting move will be. Keep this in mind when looking for opportunities to trade out of an economic indicator.
Non Farm Payrolls
An example of an economic indicator is something called Non Farm Payrolls (NFP). This is an economic indicator that tracks the number of new jobs created in the US for the past month. Forex traders tend to focus on this release, as it tends to have a prominent effect on the US dollar.
So before I explain the mechanics of trading NFP, we need to ensure we have a sound understanding of the fundamentals relating to the US dollar. It’s actually quite simple. Job creation that exceeds expectations is good for the US economy and dollar. Conversely, job creation that disappoints is bad for the US economy and dollar.
The first task when trading NFP is to identify the data’s publication date. This is generally the first Friday of every month, relating to the immediate month before. You can confirm this by using an online economic calendar, such as the one on Forex Factory. Secondly, we need to identify the time of the release, ensuring we account for timezone adjustments.
Next, we need to decide how to trade this economic indicator. My advice for NFP would be to trade out of the data. This would involve opening a trade immediately after the data’s publication. Here are the steps to follow
Follow these steps
- Locate the ‘Forecast’ figure on your economic calendar. This will detail the projected number of jobs created for the previous month.
- After publication of the NFP data, compare the actual number of jobs created to the forecast figure.
- Trade the data. If the number of jobs created has exceeded expectations, expect a USD rally. If the number of jobs is below expectations, expect USD to fall.
- Remember, broader fundamentals still apply to predicting price direction. Keep this in mind when judging price direction.
Steps to take forward
There are a number of monthly and quarterly economic indicators that you can trade. I encourage you to find an economic calendar you like, before attempting to trade these economic indicators (keeping the fundamentals at the forefront of your mind). If you need to practice doing this, I suggest you open a demo account with your broker.
I hope you’ve found this article useful. If you have any questions, please leave them in the comments below. I’ll do my best to reply to as many as I can.