Trade Forex Fundamentally

Wouldn’t it be nice to know that there was a force pushing a currency pair in the upward direction and it wouldn’t matter if you bought on a dip or your bought as price had already started to moving up (i.e. buying low or buying high)? Wouldn’t it be nice to just align yourself to a trend and make money trading forex without having to employ all sorts of indicators to figure out some exact entry? Think about this: next time you wait for price to pull back so you can “buy at a discount” in the uptrend, how do you know that price is going to reverse and go back to following the trend? What if it’s the beginning of a countertrend? It’s impossible to know by just looking at price with conventional technical analysis.

Listen up: there are so many things going on at once in the market that it’s impossible to generate any cause-and-effect relationsips–except during the 15-60 minutes after a scheduled news release. This is when the majority of market transactions are due to speculative activity. The rest of the times, large transactions between importers, exporters, and banks dominate the money flow and this is essentially unpredictable. You want to follow the speculative interest of the market because this is the immediate driver of forex price action and is influenced and easily recognized by sentiment.

Why is economic data important to trading forex profitably?

The table below is from the Forex Factory Calendar. At the site you can learn what economic releases are coming out, what economists are predicting the results to be (“forecast”) and the actual result at the exact time the information is released.

Why are we so concerned about news releases in this forex trading tutorial? First of all, in the long run, the economics between two countries ultimately dictate what price will do. In the short term it works a little differently- here’s how it works: It’s a good idea to explain how this all works before explaining you the secret techniques to make money trading forex price action during news events. Basically, governments and economic think-tanks around the world regularly (in fact daily) release scheduled data (known as “news”) that reflects the state of the economy, such as inflation rate, manufacturing activity, unemployment rate, retail sales, etc. Hedge funds and investment banks employ economic research teams to predict these numbers, such as employment, GDP, and inflation, long before they come out so that the banks and funds can put their bets on well ahead of time. When the actual release comes out, if it’s an important release and the actual number is different than forecast, the market adjusts rapidly to reflect that. For example, if the bank predicted a US ISM manufacturing survey value to increase to  50, the bank would’ve bought dollars well ahead of time. However, if the number disappoints expectations by coming out at 48, the bank, along with other speculators would sell immediately, bringing the value of the Dollar down.

As longer term (intra-week) traders, we are interested not in trading during these times, but rather, how the market reacts during these speculative periods to see how much “oomph” the market has in one direction or another.

An economic news calendar, courtesy of forexfactory.com

How do we make money trading forex due to these price reactions to news?

This nice pattern of adjusting price upward on positive surprises and downward on negative surprises doesn’t always occur! Remember, strange stuff always happens in forex and whereas it makes most traders get scared and run away, this is the best time for smart people like you and me to capitalize on these anomalies. If US manufacturing data in the above example comes out higher than expected but the USD falls or remains at the present level shortly after the release, sentiment is negative for the USD.

So how do we know where to find these releases and which ones to track? I visit the Forex Factory Calendar and look for the releases that have a red or orange indicator by them, suggesting that deviations in the actual results from predicted usually result in strong price movements because these news releases are important economic indicators to the market.  The currency that is reflected by the economic release is listed in the same row, along with the economists’ consensus for the economic number, as well as the actual number that is updated a few seconds after the actual release. It will take you a while to get used to how much of a deviation will cause a market correction, so be patient as you learn this. For the US Employment report (a.k.a. “non-farm-payrolls” or “NFP”), +/- 50K jobs is a good deviation, and for ISM +/- 2.0 is usually enough.

Example of how to make money trading forex with news price action

Let’s look at how sentiment remained largely negative in the Pound even though there was a brief countermovement to the upside. It’s important to realize that the table below features releases from both the UK and the US as the pair we are considering is the GBP/USD. Usually, when the actual result is greater than the expected/forecasted value, the currency is likely to appreciate. If the result is greater, but the price reaction following the result is opposite, then the sentiment is dominated by the direction of price reaction, because it’s a sign that the market is either too exhausted to sustain a trend in the way it “should” go according to the news release, or the market is simply a lot of momentum in the “wrong” direction. When the direction it “should” go in according to the news release and the price reaction are the same (such as in the US ISM Manufacturing example), no new information is reavealed, beacause that’s what the market normally does anyway. Notice that not all news releases have to be numerical. If a statement comes out of the central bank of a country that is economically bearish, it could weaken the currency.

How to determine forex market sentiment from price reaction to news events

 The occurances of each of the news releases above are represented at each point in time on the GBP/USD hourly chart below. Notice how even though there was an upshoot in price in the example, most of the news revealed negative sentiment so that you wouldn’t get fooled into thinking that a new uptrend was developing. When you start to see mixed sentiment from price reaction to news events or start seeing more positive reactions in a downtrend then you need to worry about a reversal, because a sentinemnt shift may be in the making. Also notice how in that entire up segment no other news releases really supported the move. This is a prime example of the things we can’t predict in the market. The market sometimes moves purely due to transactions between banks and importers and exporters- don’t give it any more credit to such a move than what it’s face value.

I just want to emphasize this because this is the most important lesson in this forex trading tutorial: If price is going in the opposite direction of the latest trend and you are wondering whether price is just pulling back before going back to the trend or is changing direction, look and see what sentiment due to news releases is showing. If little news is supporting the latest change in direction, then it is probably temporary.

Explanation of how price reacts to news events at different points of a trend (GBP/USD hourly chart)

As a last reminder, this is just one indicator. Indicators of sentiment are most powerful when used in combination with a few other (not many) indicators. We went over sentiment indicators and COT and currency strength in previous examples. In the next few posts we’ll get into how to actually enter and manage trades now that you know how to select currency pairs and directions.