[LFX]

When it comes to reacting to data reports and market events, the forex market typically displays two responses. The first reaction is a short-term, knee-jerk price response to the data report or news itself, which is where most of the intraday fireworks in the forex market go off. The second reaction, usually more important in the bigger picture, comes in later trading, when the underlying themes are updated to reflect the latest piece of news or data.

In one case, the data or news may be in line with the dominant themes of the moment, and the initial directional price reaction may be extended even further in subsequent trading action. The market may be anticipating lower Canada interest rates, for example, and a weak Canada consumer confidence report is released, sending the CAD initially lower against other currencies. Because the weaker confidence reading supports the theme that the Canadian economy is weakening, additional selling interest may materialize and lead to further price declines in the CAD.

In other cases, the data report may fly in the face of the prevailing market themes, leading to an initial reaction in the opposite direction of the recent theme. The market may be trading on the theme that Australia interest rates are going higher and that the Australia economic outlook is improving. A subsequent Australia retail sales report may come in on the weak side, potentially leading to an initial market reaction that sees the AUD weaken. Whether the AUD’s move lower will be sustained depends largely on what the market decides the latest retail sales report means in terms of the larger theme of higher Australia interest rates.

The data report may have been influenced by bad weather keeping shoppers at home, for example, and may be interpreted as just a bump in the road on the way to higher Australia interest rates. In such a case, initial AUD weakness may be short lived and eventually reverse course higher. On the other hand, the weak retail sales report may cause the market to reconsider that higher Australia Central Bank rates are a sure thing and keep on selling AUD.

Of course, there’s never a set recipe for how data and news are ultimately going to be acted on by the market. The potential data and event outcomes and subsequent market reactions are myriad, to say the least. That’s one reason the market reaction to the data is always more important than the data itself.

But as currency traders, we still have to understand what the data means to make sense of what the subsequent market response suggests for the bigger picture. The starting point for interpreting the market’s likely overall reaction is to understand the initial market response to the data / news in terms of what the market was expecting and what it actually got. We need a baseline from which to interpret subsequent price movements.