You must have heard GDP being mentioned in the news while assessing a country’s economy. Economists and financial experts use this indicator to judge a country’s economic health and growth potential. Revisions in GDP greatly impact a nation’s currency and tell a Forex trader how it is performing with respect to others.
Here, we shall be discussing GDP, what it measures, how it influences the Forex market, and how you can trade in foreign exchange using it.
What Is the GDP Indicator?
GDP or Gross Domestic Product is the net economic activity produced by public and private sector companies in a particular nation during a stipulated time period. The activity includes public consumption such as vehicles, apparel, personal expenditure, etc, investments for property and such, as well as government expenditure on defense, employee compensations, public service, etc. Additionally, the income generated through exports is added to GDP while spending on imports is deducted from it.
Generally, GDP reports encompass a quarter or a full year with the data adjusted over time until the revelation of the final yearly GDP report. While some nations release these reports every month, others issue them at the end of a quarter. Monthly reports allow individuals to closely monitor the condition of a nation’s economy.
In the USA, you can access this report on a monthly basis. Seasoned players in the Forex market are mostly concerned with the GDP growth rate, which is expressed as a percentage. Since these individuals need to compare the economic conditions of different nations while trading in currencies, GDP allows for an efficacious and simple analysis, being depicted as a change in percentage over time.
What Does It Measure?
GDP measures an economy’s net productivity value. There are three different procedures when it comes to calculating GDP, and these involve output, spending, and income respectively, which on paper, generate the same results.
In contrast, the GNP, or gross national product factors in the net output generated by individuals residing in a particular country. For instance, if a French company has an establishment in the USA, their income would be a part of the USA’s GDP and France’s GNP.
Some economic activities are excluded from GDP like unpaid labor and illegal activities since it is not easy to calculate and evaluate them. When the GDP of a country starts to rise, organizations can be seen making expansions and hiring more people as the demand for services and goods keep growing. As a result, the country’s exports will also increase and the growing economy will be reflected in its business cycle.
How Does It Impact the Forex Market?
Once the GDP report is released, a strong market movement can be seen because it has a profound impact on the economy. Following this, the market volatility can increase if the actual results are quite far off from the initial estimates.
There are several factors to consider when it comes to assessing GDP’s impact on the Forex market. Thus, usually, the market changes its behavior if the GDP report exceeds or falls beneath the forecasted value. In order to understand the impact, let us take a look at three different scenarios:
- When the GDP is below expectations: In this scenario, there is a greater possibility of Forex traders witnessing the selling off of that nation’s currency in comparison to others. Taking the example of the USA, if the GDP rate is lower than estimated, it would indicate an economic crisis and lower the probability of interest rates increasing in the country. Consequently, the financial securities based on the US dollar also become less popular and overall a currency’s value goes down when the GDP value is underperforming.
- When the GDP reading is as estimated: Even when there are no huge surprises in regards to GDP readings, Forex traders need to be aware of it, since it is important to compare this reading to that of last year or quarter. This allows them to properly assess the economic condition of a particular currency.
- When the GDP exceeds expectations: In this event, the currency becomes strong in comparison to others. Say, for instance, if the GDP of the United States rises higher, the dollar will gain strength and grow in value.
How Can You Take Currency Trading Decisions Using GDP?
Forex traders always need to be aware of vital economic data like GDP. This indicator exists as proof of the expansion in a rich economy while demonstrating the shrinkage in a poor one. Individuals trading in currencies will often search for higher GDP rates, believing that the interest rates too will go up.
When an economy is growing at a rapid pace, the consumers of goods will reap the benefits, thus enhancing the probability of expenditure. When the spending is high, the prices of goods will rise and the central bank will try to mitigate this by hiking the interest rates.
Trading Forex Using GDP Data
Once the GDP data gets released, volatility can often be seen in the market. When the GDP is more than expected, Forex traders will buy that currency anticipating the rise in interest rates. As more buyers pitch in, the value will rise further.
On the other hand, when the GDP figure is below expectations, it means that the economy is underperforming and this will lead Forex traders to sell the currency. In order to make accurate forecasts, traders often draw comparisons between the GDP of two succeeding years or quarters.
Thus, we got to know that if you are a Forex trader and want to perform fundamental analysis on a particular currency, you must take the GDP data into account. There are several financial websites where you can get this information. If you know how to make sense of the GDP data, you can become a top Forex trader.