Technical analysis dominates discussions in the world of forex. Everywhere you look, experts and novices alike depend on charting price movements to create their trading strategies. Does this mean there is no place for fundamentals in forex trading?
Ask any expert trader, and you won’t miss a mention of how people fail at forex because of overreliance on technical analysis. There is no better winning strategy than one that mixes fundamental and technical analysis.
Following economic announcements is a major part of keeping tabs on fundamentals. Good fundamental analysis means reading and reacting to news releases such as changes to interest rates, inflation data, and earnings reports.
Understanding news trading
Among the first things you hear when you join the forex market are questions such as, what kind of trader are you? What is your strategy, long-term or short-term?
As such, the market defines types of traders around their preferred strategies. Nevertheless, all traders take into account the situation in the global economy. They do so by following the content in news releases.
The key to trading news releases is to understand how they correlate with volatility in the market. Also, you have to understand that not all economic announcements carry weight. For example, news about the Turkish lira cannot create the same volatility as those related to the US dollar.
By extension, different currency pairs will react differently to news reports. Consider the EUR/USD pair. The euro and the US dollar are the two most-traded currencies in the market. Also, these currencies account for more than 60% of global trade.
Therefore, any announcement that touches global trade or geopolitical strategizing generates volatility in the EUR/USD market.
Surprise news versus anticipated news
News releases are a key component of the forex market. For context, consider the nature of the work of financial analysts. Financial analysts (FAs) are professionals whose job is to dissect the market and issue regular prognoses. The best FAs in the market can anticipate newsworthy market events with a high degree of accuracy.
Nevertheless, there are those newsworthy events that nobody can predict. For example, nobody could predict that Brits would vote to leave the EU in 2016. Although there could be a few market participants who had the right hunch, their feelings could not reach the masses.
Whether correctly anticipated or surprising, newsworthy market events create ripples that soon transform into huge waves. For the anticipated news, such as earnings reports, traders tend to place their bets close to the market consensus. Consensus in the market refers to the average expectation of key market participants, including the FAs.
What does a forex news trading strategy look like?
We have seen that the market can anticipate some newsworthy events while it is difficult to anticipate some events which could prove important to the market. Also, we should add that the currency market stands out from other financial markets in the way it reacts to the news.
Forex traders usually focus on the news items that have a direct impact on monetary policy and interest rates. As such, microeconomic news is not worth a lot to this section of the financial market.
To illustrate how news impacts forex trading, consider an announcement about a central bank decision. The world over, central bank officials regularly decide the monetary policy in light of the current conditions. When the news of the central bank decision breaks, the market reaction could be positive or negative. Let’s say the news suggests an aggressive stance by the central bank. In this case, the forex pair in question will climb – because higher rates cause a currency to appreciate against major rivals.
So, what does a forex news trading strategy look like? A typical long-term trader designs a trading strategy built around fundamentals.
The strategy considers news releases, particularly some forex indicators with a massive influence on interest rate speculation. Some of the indicators include:
- Labor statistics
- Inflation rates
- Trade deficits and surpluses
- The growth rate of the economy
- Monetary policy decisions
- Speeches by key central bank officials
Illustration: How to trade news releases
Our discussion so far tells us that a market event is newsworthy if they influence interest rate speculation. Another aspect we should throw in at this juncture is the concept of market sentiment. Market sentiment refers to the posture of the forex traders in respect to a given currency pair. Interest rate speculation and market sentiment are the anchors of this illustration.
Consider a trader who focuses on placing bets in the AUD/USD market. For him/her, any newsworthy market event that influences the value of the Aussie is crucial. Reputable international media starts to report the presence of a virus that is pushing governments to shut movements and person-to-person interactions.
The sudden stop in economic activity indicates that future demand for commodities such as base metals will fall sharply. Base metals are useful in manufacturing, and manufacturing activity tends to fall during an economic recession.
Because the Australian economy relies heavily on the export of base metals, the possibility of a drop in demand for the commodities spells trouble. If the trouble worsens into a liquidity crunch in the economy, the Reserve Bank of Australia (RBA) is ready to act. The most likely policy option here is to cut interest rates.
Suddenly, the market sentiment turns negative against the AUD, and the AUD/USD pair falls dramatically. Why did this happen? The dovish news from the RBA initiated the transfer of capital from Australia to the US.
Consequently, falling demand for the AUD in favor of the greenback caused the exchange rate to move up in favor of the USD.
There is a critical takeaway from the illustration above. The forex market associates each currency with certain aspects of the economy.
For example, the market associates AUD with commodities. Other notable associations include the New Zealand dollar (NZD) with dairy and livestock products, the Canadian dollar (CAD) with crude oil, the Russian ruble with natural gas, etc.
Therefore, the best forex news trading strategy considers all the common associations between the currency (currency pairs) and aspects of the global economy.