Influence of Indicators & Which Ones To Follow

Whilst there are a vast number of indicators which are released daily, not all will influence the forex markets, and indeed many of the fundamental news releases are flagged as high, medium or low priority to indicate this fact. As you would expect, those with a high priority are considered extremely important and followed by virtually all the forex market participants, whilst those rated as low priority will have little impact. Indeed, one wonders sometimes why we have so many at all. It is also important to realise that over time, trends change, with certain groups of indicators gaining favour, whilst others become less popular and fall out of favour. To illustrate this point, in the early 1990′s, many forex traders were largely focused on the balance of payments, and in particular the current account, but its influence on price discovery has receded in the last few years, and has consequently become a less important indicator as a result. In contrast the employment indicators have grown, both in number and in importance recently.

In addition to the changing trends of indicators over time, the influence of these numbers also changes as the economic climate varies, an effect we see constantly in the forex markets. If we take inflation as an example, and a period where this has been low, then the release of inflation related data, where no substantial increases are expected, will have little or no impact on the markets. If, on the other hand, we are at an extreme for inflation levels, and in danger of breaching the limits defined by the central bank or government, then the focus on the release will be high, with a consequent volatile reaction on the news as the headline number draws attention from the market players as a result. Indeed a recent study into the effects of various economic indicators on the forex markets was able to draw the following conclusions, and list the key indicators in order of importance as follows :

  1. Employment numbers
  2. Interest rates
  3. Inflation
  4. Balance of payments
  5. GDP

It is interesting to note that GDP is at the bottom of the pile whilst the plethora of employment data is currently in favour, even coming ahead of interest rates in terms of market impact. This can partially be explained by the recent turmoil and economic collapse of both the banking infrastructure and the broader economy, that has resulted in many Western countries now adopting historically low interest rates, which seem set to remain in place for some time to come. As a  result, interest rates are no longer viewed by the forex markets as particularly exciting or likely to reveal any surprises, as it obvious to all market participants that central banks have little room for manoeuvre at present, and most have even run out of capacity to lower them further. As a result, interest rate releases are virtually ignored at present. Employment data however, is of course closely watched, as it is generally considered to be a leading indicator and therefore is likely to provide the first signs of any recovery or turning point in the broader economy. In any analysis of forex trading indicators, it is therefore always useful to remember where we are in the economic cycle, and to consider whether the indicator being released is likely to have a high or low impact, in the current climate.

Finally, in this study of some of the more important forex trading indicators, we need to consider the forex markets and how they behave when these figures are released, as they often react in an irrational and unpredictable manner. Whilst this can partially be attributed to the irrational behaviour of markets, there is perhaps a more ‘rational’ explanation, and one which is seen repeatedly when trading forex and which concerns the human behaviour and trading psychology. Put simply it is this – if the markets have a positive sentiment towards a particular currency, and the news release is worse than expected, then the markets will generally undervalue this item of news, and in a sense almost ignore it, as it fails to meet expectations. The corollary to this is where the sentiment is positive and the news is good, then the currency will react beyond all reasonable expectations and move far more strongly than is reasonable. This effect is seen all the time and also works in reverse, where negative sentiment and positive news have little effect, yet negative sentiment and negative news have a large impact. The latter effect is much in evidence in the euro currency at present, where overall market sentiment is heavily negative, and bad news forces the currency lower than one would normally expect when sentiment is more balanced.

In addition to the above effect there is also of course the expectations of market players prior to any release, as trading positions are often built in advance of the news. If the data is on forecast, then they have no reason to react, and as a result the forex exchange rates hardly move if the numbers are in line with expectation. This is one reason why the forex markets often fail to move even when the fundamental news is very bad – provided the news was expected to be bad, then the market players will have built their trading positions accordingly. What causes the extreme market volatility is when the news release deviates from the market forecast, and can also explain why markets move higher when the news is bad.

Put simply, if negative news is expected and the actual numbers are not so bad, then traders and investors buy the market, pushing the currency higher as a result. The rationale behind this move is simple, in that it is not the number that matters, but how this relates to the forecast and market expectation. Good news that fails to meet the forecast may cause the currency to fall, whilst bad news that is perhaps not quite as bad as expected will cause the currency to rise. The key point to realise is that it is the forecast that is important, not the numbers being released, and is a reaction seen time and again in the equities markets as earnings seasons come and go. If the analyst expectation for a stock or share is met or exceeded then the price is likely to move higher, but a good performance that is short of market forecast ( even by a small margin) will send the share price tumbling. It is this relationship between the forecast and the release that is so important, and the reason you need to be well versed in all the forex trading indicators, and the forecasts for each day which you can find on the economic calendar, before opening any trading positions.

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