Forex Investment and Currency Trading

Economic indicators are snippets of financial and economic data published by various agencies of the government or private sector. These statistics, which are made public on a regularly scheduled basis, help market observers monitor the pulse of the economy. Therefore, they are religiously followed by almost everyone in the financial markets. With so many people poised to react to the same information, economic indicators in general have tremendous potential to generate volume and to move prices in the markets. While on the surface it might seem that an advanced degree in economics would come in handy to analyze and then trade on the glut of information contained in these economic indicators, a few simple guidelines are all that is necessary to track, organize, and make trading decisions based on the data.

Know exactly when each economic indicator is due to be released. Keep a calendar on your desk or trading station that contains the date and time when each statistic will be made public. You can find these calendars on the N.Y. Federal Reserve Bank web site using this link: http://www.ny.frb.org/. Then search for economic indicators; The same information is also available from many other sources on the Web or from the company you use to execute your trades.

Keeping track of the 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 U.S. Dollar has been in a tailspin for three weeks. As such, it is safe to assume that many traders are holding large short USD positions. However, the employment data for the United States is due to be released on Friday. 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 affect prices directly (following their release to the public) or indirectly (as traders massage their positions in anticipation of the data).

Understand which particular aspect of the economy is being revealed in the data. For example, you should know which indicators measure the growth of the economy (GDP) versus those that measure inflation (PPI, CPI) or employment (nonfarm payrolls). After you follow the data for a while, you will become very familiar with the nuances of each economic indicator and which part of the economy it measures.

Not all economic indicators are created equal. Well, they might have been created with equal importance but along the way, some have acquired much greater potential to move the markets than others. Market participants will place higher regard on one statistic versus another depending on the scale of the economy.

Know which indicators the markets are keying on. For example, if prices (inflation) are not a crucial issue for a particular country, the markets will probably not as keenly anticipate or react to inflation data. However, if economic growth is a vexing problem, changes in employment data or GDP will be eagerly anticipated and could precipitate tremendous volatility following its release.

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 percent 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 percent. 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 have taken advantage of tbe 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.

Do not get caught up in the headlines, however. 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 nonfarm payrolls figure. Other economic mdicarors 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 statistic most closely watched by the markets is PPI, minus food and energy price changes. 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.

Speaking of revisions, do not be too quick to pull that trigger should a particular economic indicator fall outside of marker expectations. Contained in each new economic indicator released to the public are revisions to previously released data. For example, if durable goods should rise by 0.5 percent 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 have been originally reported as a rise of 0.5 percent but now, along with the new figures, it is being revised to indicate a rise of only 0.1 percent. Therefore, the unexpected rise in the current month is likely the result of a downward revision to the previous month’s data.

Do not forget that there are two sides to a trade in the foreign exchange market. So, while you might have a 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 G8 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 that country’s economic indicators. As mentioned earlier, 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 so you won’t be caught off guard.

When it comes to focusing exclusively on the impact that economic indicators have on price action in a particular market, the foreign exchange markets are the most challenging. Therefore, they have the greatest potential for profits of any market.

Obviously, factors other than economic indicators move prices and as such make other markets more or less potentially profitable. But since a currency is a proxy for the country it represents, the economic health of that country is priced into the currency. One very important way to measure the health of an economy is through economic indicators. The challenge comes in diligently keeping track of the nuts and bolts of each country’s particular economic information package. Here are a few general comments about economic indicators and some of the more closely watched data.

Most economic indicators can be divided into leading and lagging indicators. Leading indicators are economic factors that change before the economy starts to follow a particular pattern or trend. Leading indicators are used to predict changes in the economy. Lagging indicators are economic factors that change after the economy has already begun to follow a particular pattern or trend.

The problem with fundamental analysis is that it is difficult to convert the “qualitative” information into a specific price prediction. With FOREX leverage being what it is, it is seldom enough to know that a report is “bullish” for a currency without being able to attach specific values.

Econometric analysis attempts to quantify the often qualitative fundamental factors into a mathematical model. These models can become enormously complex. The problems with econometric analysis are twofold: It is difficult to objectively quantify qualitative information such as a news announcement. The interactions and specific weights of each factor are constantly in flux and the relationships between them are almost certainly nonlinear. Relationships that hold today are invalid tomorrow.

Even if you opt for a technical analysis trading approach, as most traders do, do not completely ignore the fundamentals. Use a new service to do a daily take on what’s happening. Remember: Be aware of pending reports, statistical releases, and so on, as they often will cause a violent market reaction one way or the other.