HOW TO USE THE ECONOMIC NEWS FOR TRADING
How To Use The Economic News For Forex Trading
The dynamic forex market is strongly driven by news events. Therefore, traders follow the economic news closely in order to anticipate market movements, and make profitable trading decisions based on this. Here is a guide to the most relevant news releases to follow, and how you can use this information to best influence the outcome of your trades.
Which type of news is important in forex?
The most relevant news to forex is economic data releases, such as Gross Domestic Product (GDP), inflation, Consumer Price Index (CPI), interest rates, and unemployment figures. There is data released on a daily basis for all of the major currencies. As the US dollar (USD) is the most popular currency, the market responds to US based data most sharply.
Keep an eye on countries which have other major currencies including the Euro (EUR), the British pound (GBP), the Canadian dollar (CAD), the Japanese yen (JPY), the Australian dollar (AUD), the Swiss franc (CHF), and the New Zealand dollar (NZD).
How should you select which news releases to follow?
Of course, you should select which news to follow based on the currency pairs that you trade with. Be aware that some data will only have a low impact, so it is important to know what the key releases are, and how they affect your chosen currency pairs. The significance of the data varies according to the country, and the state of the economy at the time.
Traders use the economic calendar to keep track of upcoming data releases and events that affect the movement of the markets. Each country or major economy will have a specific economic calendar, which can usually be viewed online for free. Bear in mind that there may be discrepancies between them, depending on who the website is aimed at.
As you become more experienced at forex trading, you will probably find that you need a customisable calendar, so you can focus in the currencies and indicators which are most relevant to you. Most of the information on the calendars relates to current financial and economic reports, and projections and consensus about future financial events.
Unemployment rates
The unemployment rate is one of the key releases that impacts the forex market. The world’s major economies are designed to maintain a low rate of unemployment, which means that the majority of the workforce can obtain gainful work, either as an employee, or through self-employment. It’s a sign of a healthy economy that is functioning well.
On the other hand, a high unemployment rate is a sign of a struggling economy. Consumers will have less money to spend on non-essential goods and services. Government expenditure and borrowing will increase, because of extra pressure on the benefits system, and reduced tax revenues.
All this reduces the demand for imported and domestic products, so the GDP of the economy is lowered, which also affects the value of the currency exchange rate. This means that foreign investors will look elsewhere, and this further depreciates the currency.
The central bank may respond to a higher unemployment rate by cutting the interest rate to encourage more borrowing and spending. This in turn may lead to a movement in the forex market. If the unemployment rate is reducing, the central bank might decide to raise interest rates, to control inflation and add value to the currency.
The major economies release monthly unemployment statistics, which are followed by a short period of volatility in the markets. If the rates are higher than expected, the currency of the country is likely to take a downturn. Conversely, if the rates are lower than expected, the markets may respond with an upswing, based on the prospect of higher interest rates.
Therefore, in the hours after the latest statistics are released, forex traders will look to sell the currencies of countries with higher-than-expected unemployment rates, and buy the currencies which are supported by a lower-than-expected figure.
Other key indicators
The unemployment rates are key because they tie in with most of the other major indicators, such as the GDP, interest rate, inflation rate, retail sales, consumer confidence surveys, trade balance, business sentiment surveys, and the CPI. Sometimes, the market will prioritise one particular release over another, so keep an eye on what is trending.
For example, energy prices are volatile at the moment. Prices have been rising sharply in the past few months as a consequence of shortages, Covid disruption, and the sanctions against Russia following its invasion of Ukraine.
The Organisation of the Petroleum Exporting Countries (OPEC) controls about 44% of the world’s crude oil production, and therefore holds an influence over oil prices. This means that currencies of countries such as the US and Canada, which are major oil producers, are more affected by changes in oil price than those with low or no oil reserves.
The markets also react strongly to geopolitical events, such as elections, wars, civil and political instability, pandemics, and natural disasters. Therefore, keep an eye on the current affairs of those countries who use your trading currencies.
News trading strategies
So now you know what news items to follow, but how do you apply them to your trades?
Spreads in forex widen during periods of volatility, meaning that the difference between the broker’s sell rate and buy rate increases, and this heightens the risk of losses. The major currency pairs tend to be least affected by this, so if you are relatively new to forex trading, it’s best to stick with those, and avoid exotic currencies.
Sometimes, the predicted reaction will not occur, or the opposite reaction may happen. There may be a whipsaw effect, which is where the market shoots in one direction, only to bounce sharply back in the other direction. If you hastily make a move before being certain how a particular currency will react, you will risk incurring heavy losses.
Why is consensus important?
Before the news item is released, analysts will reach a consensus on what that data will contain. For example, based on the available stats and other information, they may predict that the UK unemployment rate will increase to 6%. This would mean that major traders sell off their GBP, and buy up other currencies, ahead of the news.
If the rate is confirmed at 6%, although this represents a weaker economy, the currency rate for GBP may not be affected. This is because the most influential traders have already made their move. If the data was unexpected, such as a fall to 5%, then the demand for GBP might shoot up, because lower unemployment rates are a sign of economic strength.
This is not to say that this will definitely happen, because other factors also influence currency price, or the higher employment rate can be explained by an uptake in seasonal temporary employment. It is important to look for a range of influences, rather than have an individual focus.
Trading before the news release means you can enter the market in a lull. Read up on the consensus, so that you know how the market is likely to react. As we have seen, this is not without risk, as sometimes the consensus is not played out in the actual figures. This is likely to cause high volatility in the markets.
It is advisable to use stop loss or stop limit orders to mitigate against losses or protect your profits, should the news defy expectations and the markets turn strongly in the wrong direction.
Trading post-news release
It is a more common strategy to trade post-news, which is referred to as the breakout. It may be tempting to respond instantly, but the best strategy is usually to wait and see what the reaction in the markets will be. The movement in the first minutes or hours after a release can be distorted by speculative traders, who will not drive longer term trends.
Although it is possible to take a profit from speculative trading, experienced traders will avoid this, due to the higher level of risk comparative to the potential rewards. Wait it out, until the artificial spike in the market has passed. Most news is traded on a short-term basis of days, but sometimes the impact may be felt for weeks.
Research the previous performance of the news release you are interested in, to see whether it plays out with a short term or a long-term impact. For a short-term trade, monitor support and resistance lines, and identify potential bounces. Buy at a point just slightly below the level of support, and sell near the level of resistance.
For a longer-term trade, track the overall trend rather than the smaller fluctuations that occur within short timeframes. Remember that there will always be an element of unpredictability when trading on forex news releases, so it is essential to have a robust risk management strategy in place.
Know in advance how much money you are prepared to lose in the worst-case scenario, and do not be tempted to go over your limit in the heat of the moment. News trading can be particularly high-pressure, as there are so many variables and unknowns, so you need to toughen up psychologically as well as have a solid trading strategy.
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