|What kind of effect do business cycles, asset allocation, and economic indicators have on forex? Understanding such relationships may determine your success in trading the foreign exchange market. In my July 2005 STOCKS & COMMODITIES article "Forex, Anyone?" I mentioned the immediate impact that changing economic indicators had on forex: more so, it turned out, than on common stocks. In recent years, the global economic picture has never been worse. So I decided to explore the topic, using personal trading experiences and notes gleaned from books, articles, and seminars. I have also found that exploring the content found in the websites listed in the sidebar "Economic Indicator Calendar" was an invaluable aid in understanding economic indicators.|
ENTERING THE FOREX TRENCHES
The reason is simple. Although you are trading a currency pair (buying one currency and selling the other), you are only charting the tick-by-tick changes in the ratio of the two currencies. So if the EUR/USD is pegged at 1.95, it would take $1.95 to buy one euro. It is this ratio you are trading, and thus, it charts as a single entity just like a stock does (for example, up to $1.97, down to $1.94, and so on).
This ratio is determined by the respective differences in the interest rate of each country. Remember you always trade the base currency and never the secondary currency. You don't have to remember the formal names. Just think of a pair as a fraction: you always trade the numerator (the top number).
Can you trade these currencies the way you have been trading your stocks? From your preliminary studies, you have observed that as long as the dollar continues its long slide, there should be a good chance to make a few bucks trading the euro/dollar. Then again, nothing is certain.
What pushes the dollar down? What pushes it up? What tools do we need to anticipate these swings? Our first response may be to answer "world events." After all, currency markets react to real-time news. A catastrophe in Japan may not have an immediate effect on IBM stock, but if we were trading the US dollar/yen, in one minute you could get wiped out or have the means to retire. And if we can equate Greece's debt crisis to the bad apple in the barrel, then the rest of Europe can be likened to the rest of the barrel. Will the Greek debt crisis weaken the euro? If we see a third round of quantitative easing, the Standard & Poor's 500 will undoubtedly increase along with a falling dollar. Long story short: we need to know about business cycles, asset allocations, and economic indicators.
Whether we're in a bull market of early recovery or a bear market of early recession, the phase of the business cycle we are in plays a role. As far as your asset allocation is concerned (the mix of stocks, bonds, cash, and gold), financial managers recommend you should reexamine your portfolio at least once a year and make whatever changes are dictated by the changing times. Are you currently converting everything to cash, or are you going long on stocks? Your current personal situation is also a deciding factor for trading forex.
While these two major factors are beyond the scope of this article, economic indicators are not. These indicators are more easily identified, the positive and negative effects are well known, the information is released regularly on a known schedule, and it is available on the Internet. And when the market opens at 0930 am Eastern time (ET), every financial station will lead off with that day's economic data. Here are the most market-sensitive indicators:
Market reaction: Report up = bonds down, stocks up, dollar up
Market reaction: Unemployment up = bonds up, stocks down, dollar down
|Institute for Supply Management (ISM) Report|
This report on the state of the economy is heavily influenced by the manufacturing industry. It is released at 1000 am on the first business day of the month; thus, it may precede or coincide with the employment report. This report has been produced since 1931. At that time, the ISM was known as the National Association of Purchasing Agents. Purchasing managers across the country are engaged in the procurement of all the supplies that are needed by the manufacturing industry. The industries that produce these goods make up a good part of our economy's output. This data is important enough that the Federal Reserve is briefed before its release to the public. The Purchasing Managers Index (PMI) is regarded as a barometer of the economy's health. An index above 50 is a sign that manufacturing is growing, while below 50 is a sign of weakening manufacturing. An index of 50 indicates no change.
Market reaction: Report up = bonds flat, stocks up, dollar up
As fate would have it, I was in the process of writing this paragraph at 0945 am on September 1, 2011. At precisely 1000 am, the index was announced at 50.6. We would have expected the dollar to jump along with stocks with this news. Actually, The EUR/USD jumped 22 pips at 1000 am, and then from 1004 am through 1015 am, it fell 92 pips. The Dow Jones Industrial Average (DJIA), which was trending down from 0930 am to 0959 am, jumped 90 points at 1000 am and then fell more than 200 points that day. From this, we can conclude that nothing is certain.
Consumer Price Index (CPI)
Market reaction: CPI up = bonds down, stocks down, dollar down
Producer Price Index (PPI)
Market reaction: PPI up = bonds down, stocks down, dollar down
Market reaction: Retail sales up = bonds down, stocks up, dollar up
Consumer Confidence and Sentiment Surveys
Market reaction: Confidence up = bonds down, stocks up, dollar up
Personal Income and Spending
Market reaction: Spending up = bonds down, stocks up, dollar up
|These are by no means all the economic indicators affecting the currency market, but they are the major factors. The sidebar lists several more indicators, which you might want to research. Your results can be measured in dollars and cents.|
SIDEBAR: ECONOMIC INDICATOR CALENDAR