Forex Trading Articles

FUNDAMENTAL ECONOMIC INDICATORS ARE ESSENTIAL FOR PREDICTING FOREIGN EXCHANGE (FOREX/FX) CURRENCY MARKET PRICE ACTION

By Larry Litchfield for Forexmentor.com
©2007, Currex Investment Services Inc.

Jan. 14, 2007

The vast amount of available economic information can be mind-boggling to currency traders. Factor in that each of the major, minor and exotic currencies also have a central bank and consequently have similar objectives and economic indicators. Is it any wonder that some traders think an advanced degree in Economics is necessary to thoroughly understand and analyze the economic indicators? Or, have you ever asked how can I make sense of all the data and make sound trading decisions?

In each of these cases I bring you both good news and bad news. First, the bad news for some traders is that people trained in Economics do have some advantage over those who are not trained. The good news is that only a few simple guidelines to go with the above indicators are all that is necessary for you to be able to make sound trading decisions based on an understanding of the available data and how things come together.

Some of the following guidelines have been available in the public domain for the past few years.

1. Know the announcement date and time for each economic indicator . There are a number of economic calendars available on the Internet. They are usually available and current by the beginning of trading on each Sunday night (EST). Please click on the links and bookmark each of the following two popular calendars. Print them out and keep them visible at your workstation. Incorporate them into your daily top down analysis.
   
   http://www.forexfactory.com/index.php?page=calendar . This is a handy comprehensive calendar because it has a unique legend for identifying high, medium and low impact indicators. You can also read a brief description of each indicator. Highly recommended!
   
   http://www.dailyfx.com/calendar/briefing. After this loads click on WEEKLY FOCUS in the left margin for the current week.
   
   The reason for suggesting two calendars is because sometimes there are announcements on one calendar and not the other. Be sure to check them both. Nothing can be more frustrating and confusing than to watch the market react to an announcement that you did not know about.
   
2. Keeping track of a calendar of economic indicators will also help you make sense out of otherwise unanticipated price action in the market . Consider this scenario: it's Monday morning and the USD has been in a tailspin for three weeks. As such, it's safe to assume that many traders are holding large short USD positions. However, on Friday the employment data for the U.S. is due to be released. It is very likely that with this key piece of economic information soon to be made public, the USD could experience a short-term rally leading up to the data on Friday as traders pare down their short positions. The point here is that economic indicators can effect prices directly (following their release to the public) or indirectly (as traders massage their positions in anticipation of the data.)
   
3. What is the specific component of the economy being revealed in the data? Lets say a country is experiencing a problem with economic growth. Consequently changes in the employment data or GDP will be enthusiastically anticipated and that could lead to significant volatility at release. Likewise, if inflation (price) is not a critical issue in a particular country, inflation data will not be of interest to the markets.
   
4. Economic indicators are not created equal. The simple fact is that the release of some indicators will move markets significantly more than others. Traders place a higher regard on one indicator vs. another depending on general conditions of the economy. Non-farm payroll data and FOMC announcements are two indicators that move often move the market.
   
5. Know which indicators the markets are keying on? For example, if prices (inflation) are not a crucial issue for a particular country, inflation data will probably not be as keenly anticipated or reacted to by the markets. On the other hand, if economic growth is a vexing problem, changes in employment data or GDP will be eagerly anticipated and could precipitate tremendous volatility following their release.
   
6. The data itself is not as important as whether or not it falls within market expectations . Besides knowing when all the data will hit the wires, it is vitally important that you know what economists and other market pundits are forecasting for each indicator. For example, knowing the economic consequences of an unexpected monthly rise of 0.3% in the producer price index (PPI) is not nearly as vital to your short-term trading decisions as it is to know that this month the market was looking for PPI to fall by 0.1%. As mentioned, you should know that PPI measures prices and that an unexpected rise could be a sign of inflation. But analyzing the longer-term ramifications of this unexpected monthly rise in prices can wait until after you've taken advantage of the trading opportunities presented by the data. Once again, market expectations for all economic releases are published on various sources on the Web and you should post these expectations on your calendar along with the release date of the indicator.
   
7. Don't get caught up in the headlines. Part of getting a handle on what the market is forecasting for various economic indicators is knowing the key aspects of each indicator. While your macroeconomics professor might have drilled the significance of the unemployment rate into your head, even junior traders can tell you that the headline figure is for amateurs and that the most closely watched detail in the payroll data is the non-farm payrolls figure. Other economic indicators are similar in that the headline figure is not nearly as closely watched as the finer points of the data. PPI for example, measures changes in producer prices. But the stat most closely watched by the markets is PPI, ex-food and energy. Traders know that the food and energy component of the data is much too volatile and subject to revisions on a month-to-month basis to provide an accurate reading on the changes in producer prices.
   
8. Speaking of revisions, don't be too quick to pull that trigger should a particular economic indicator fall outside of market expectations. Contained in each new economic indicator are revisions to previously released data. For example, if durable goods should rise by 0.5% in the current month, while the market is anticipating them to fall, the unexpected rise could be the result of a downward revision to the prior month. Look at revisions to older data because in this case, the previous month's durable goods figure might've been originally reported as a rise of 0.5% but now, along with the new figures, is being revised lower to say a rise of only 0.1% Therefore, the unexpected rise in the current month is likely the result of a downward revision to the previous month's data.
   
9. Don't forget that there are two sides to a trade in the foreign exchange market. So, while you might have a great handle on the complete package of economic indicators published in the United States or Europe, most other countries also publish similar economic data. The important thing to remember here is that not all countries are as efficient as the G7 in releasing this information. Once again, if you are going to trade the currency of a particular country, you need to find out the particulars about their economic indicators. As mentioned above, not all of these indicators carry the same weight in the markets and not all of them are as accurate as others. Do your homework and you won't be caught off guard.
   
10. Always try to determine if the projected indicator is expected to be USD positive or USD negative. If the news is USD positive then the price of the EURUSD and GBPUSD will go down. Conversely, with the USDJPY and USDCHF the price should rise. Likewise, if the news is USD negative, prices of the aforementioned currency pairs will react in the opposite direction.

Once again, always remember you can do a Google search on most any indicator and you can learn all there is to know about that indicator. But, a word of CAUTION!!! Remember there is such a thing as “information overload” which can often lead to “paralysis by analysis”. To avoid overload and for obvious reasons, most currency traders prefer using technical indicators. Although this notion makes sense to many, keep in mind trading in the currency markets without knowing the exact nature of its underlying elements can be similar to building a house without a hammer. Although you might be successful trading only technical indicators I can assure you that your trading results will be far greater over the long haul if you combine your technical knowledge with your fundamental knowledge.

For currency traders, fundamentals represent everything that makes a country tick. From interest rates and central bank policy to natural disasters, fundamentals are a dynamic mix of distinct plans, erratic behaviors and unforeseen events. Therefore, it is always better to get a handle on the diverse mix of important economic indicators than it is to simply formulate a comprehensive list of them.

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