Did you ever think of how the forex market really works and what is behind the price movements? In today’s blog, we will take a look at the most important economic data releases and how they might affect the prices we see on the charts. If you want to make money in the Forex market, you must know why the Forex market moves in the way it does.
How is economic data used?
There are two main categories of Forex traders:
- A technical trader who analyzes the chart at previous price action and determines where prices may go in the future.
- A fundamental trader who capitalize on a country’s strength based on its economic standing relative to another economy.
Of course, traders can also be a combination of both fundamental and technical, but either way, it’s important to have an understanding of what it’s driving the Forex market.
Trading the foreign exchange currencies it basically means to trade two separate countries’ economies against each other. This requires clues to show how one economy is performing relative to another.
Throughout the week are several economic data releases, individual governments release sets of data that shows how an economy is performing. We use these data releases as an indication of where the currency may go in the future.
How the economy of a country works?
The country’s currency is a gauge of the country’s economic standing and at the centre of any currency is the central bank.
The central bank has the power to set interest rates that ultimately dictate the value of a country’s currency. In simple words, interest rates are set to control currency.
If interest rates are going up, it usually means that the currency will get stronger, as investors will buy and invest to get a higher return.
The central banks around the world are generally mandated to manage inflation at around 2%. If interest rates are going up, it encourages savers to save more money, and the borrowers to borrow less money. If interest rates are low, it means that people can borrow more money, so they’re spending more money which will result in an increase in the prices.
This means inflation is heading higher, so interest rates may have to move higher to protect their inflation targets.
Remember, inflation isn’t a bad thing and 2% is considered healthy for an economy. Anything above 2%, 3, 4, 5, get into hyperinflation which means the dollar in your pocket is going to worthless and the country will ultimately go into a recession and contract.
Key Economic Data Release:
- Consumer Price Index (CPI) is the key indicator released once a month. It’s basically inflation and it shows what’s happening to prices at the consumer level.
- Producer prices comes out once a month as well and it offers an indication of the prices from the producers. If the prices increases or decreases, they will pass that on to the consumer, so it’s a leading indicator for the consumer prices.
- Retail sale is a key indicator which basically tells us what consumers are spending on the high street or online. If retail sales are going up, it means we’re all spending money, the prices go up (and the CPI goes up).
- Purchasing Managers Index (PMI) is basically a survey of business leaders in different sectors such as manufacturing, construction, and services. They do a survey of these business managers and ask them about their outlook. Anything above survey reading of 50 is considered an expanding economy and below 50 means that the economy is actually contracting.
- Probably the most important number in the calendar month is the employment number. Everything focuses on employment because more jobs mean spending more money, so the prices, the inflation and in interest rates go up.
- For the USA is called NFP and it stands for NonFarm Payroll. It’s usually on the first Friday of the month and I stream it live and trade it on our ForexSignals TV YouTube channel. This indicator tells us if are people earning more money this month than they did last month.
If the inflation goes up, central banks may have to move interest rates and the currencies should follow as well.
- Durable goods (white goods) are items that you don’t buy every month like washing machines, refrigerator. These big-ticket items are a gauge that you’re confident with your money.
- Gross Domestic Product (GDP) tells if the economy is expanding or it’s contracting. If the economy is expanding, then it possibly means inflation is going to push up higher and the central banks may have to act on interest rates.
- Housing data represents home sales, housing starts and mortgage approvals, it shows what’s happening to the housing market. If people are buying houses, it means they’re earning more money so inflation goes up and central banks may have to act on interest rates.
Throughout the calendar month, the central bankers are always on the newswires, making comments and giving interviews. They’re giving away hints or clues about interest rates. If they move interest rates higher, generally speaking, the currency should go up. If they move interest rates lower, the currency should go down.
The point is to look at the analyst view, then to review the release and act accordingly.
Hopefully, now that penny has dropped, you understand the basic economics and the reasons why the currency markets move.
As always if you liked this blog, leave a comment below. Until next time happy trading and good luck! I hope to see you in the Trading Room.
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