News releases provide fresh information about how an economy is performing. If the data is surprising enough, the market's reaction can last for a few minutes, hours and sometimes even days. Trading news through currencies can be exciting but also risky, because of the volatility that can be triggered by the news event. Some forex traders love to trade news because of the potentially big reactions, but these same swings can also make news trading difficult.
Not all news releases are created equal. The most important thing about trading news is knowing which events matter. For example, there is no point in positioning ahead of the New Motor Vehicle Sales report from the Australian Bureau of Statistics, because it rarely affects the forex market.
The number of new motor vehicle sales in Australia is not a game changer for the economy. The Australian employment report, on the other hand, is a very big market mover. The degree of job growth directly affects consumer spending, which is the engine of growth for every economy.
Step One: Identify which news releases matter
The first step to news trading is to understand which news releases matter. Economic calendars, such as the one on FX360.com, will rate the impact of each news events as high, medium or low. Generally speaking, the three most potentially market moving releases for currencies are employment report, retail sales and the central bank's rate decision. Let's examine how each of these releases can be forecasted and the potential impact on the currency.
Tip: To help forecast employment, look at the employment component of PMI reports.
The degree of job growth or lack thereof is very important to a country's economic outlook. If the labour market is doing well and jobs are plentiful, it is usually synonymous with a strong and improving economy. If companies are laying off workers in size, there is a good chance the economy is weakening. Forecasting the potential surprise in the labour market is not as difficult as it may seem. For example, Australia releases the purchasing managers' index every month for the service, manufacturing and construction sectors prior to the official employment report. Within each of these reports is a subcomponent titled "employment."
If the employment component of the three reports increased from the previous month, there is a good chance that the number of jobs created increased as well. However, if the three reports show that the labour market has deteriorated, there is a good chance that the official labour market report will show the same deterioration. A good jobs number is typically positive for the currency, while a weak number will usually cause the currency to sell off.
Tip: To help forecast retail sales, look at the confidence and sales component of PMI services.''
The degree of consumer spending is just as important as the amount of job growth because it measures the contribution that consumers are making to the economy. If consumers are spending and retail sales are strong, there is a good chance the economy is growing which is positive for the currency. If it is weak, that usually translates into weakness for the currency.
Forecasting the potential improvement or deterioration of retail sales is also not as difficult as one might expect. For Australia, the performance of services index is released most months before retail sales. Within the PSI report, there is a subcomponent titled "sales." The PSI report is released by the Australian Industry Group, which is an independent, not-for-profit association, and its results have a decent correlation with the government's figures.
The following chart shows how the Australian dollar sold off against the US dollar after the retail sales report, which cooled in the month of May. Retail sales rose 0.2 percent compared to 0.6 percent the previous month.
Source: GFT DealBook 360
Central Bank Rate Decision
Tip: Central banks look at inflation, employment and consumer spending.''
Central bank meetings are extremely important, because the changes banks make to interest rates affect the borrowing cost for everyone, from big corporations to individuals. The amount that a bank charges for loans and monthly credit card interest payments are all tied to the nation's official interest rate. Therefore, any hint of a rate change or reluctance to continue tightening or easing could have a profound impact on the currency.
For most of 2010, central bank rate decisions were non-events, because aside from the Reserve Bank of Australia, most other central banks were sitting on their hands. However, this is the beginning of change with the Reserve Bank of New Zealand and the Bank of Canada raising interest rates by 25bp in June. Unlike employment and retail sales reports, central bank rate decisions are more difficult to trade because the rate change and the comments from the central bank could affect how the currency behaves.
Step Two: Decide whether to position before or after a release
After determining which event risks are tradable, the next step is to decide whether to position before or after the release. Fundamental traders who are able to connect the dots between things like the sales component of the PSI with retail sales may prefer to position before the data because once the number is released, the immediate reaction could provide instant gratification.
For traders that may find it difficult to predict economic data, it may be smarter to wait until after the economic report is released. As you can see in the AUD/USD chart above, if the surprise is significant enough, the initial move will continue. However, with post news trades, profit targets may need to be more conservative because the initial knee jerk reaction may already be a large part of the move.
Step Three: Protect yourself and make sure you set a stop
When trading news, it is extremely important to use a stop because of the potential for wild swings. For traders positioning ahead of a data release, setting a stop is critical in case the economic release is forecasted incorrectly. Even for traders positioning after the data, the currency pair could retrace. Using a stop is a key component of forex trading.
'''''Which news event are you most likely to trade and why? (Share your views below)
Want to learn more about trading CFDs? Download GFT's free CFD guide, get a risk-free practice account and visit gft.com.au for more information. Ready to start trading? Open an account with GFT with as little as $275. Don't forget to follow Kathy's commentary on FX360.com and Twitter.