Foreign Exchange 4U - Currency & Forex

Why Does The Non-Farm Payrolls Report Cause Volatility?

The NFP generally falls on the first Friday of every month and offers an insight into the health of the US labour market. A healthy labour market is an important driver of consumer spending which, in turn, stimulates economic growth and prosperity. The health of the US economy is directly proportional to the strength in value of the US Dollar. This grabs the attention of banks and individual speculators alike. Therefore, few markets feel the effects of this data release like foreign exchange, especially the dollar currency pairs such as EURUSD (Euro vs. US Dollar) and GBPUSD (Great Britain Pound vs. US Dollar).

What Were We Dealing With?

Price reaction to a Non-Farm Payrolls report can vary from a uni directional rally to a mess of chop with no clear directional bias. Given the choice every trader would love to see one-way traffic every time but as we know that is not a reality. On the day in question we saw a brief, but rapid dollar sell off, followed by a sudden directional change. This resulted in a nasty whipsaw. We will go into the reasons for this below.

Why Did This Happen?

The NFP report on Friday 6th was a tricky one. The headline figure came it at +51 000, the lowest figure since October 2005. With a poor figure such as this one you would expect a dollar sell off and we can see this in the spike higher on the EUR and GBP pairs. However, this move faltered quickly as traders realised that the previous month's data had been revised upwards from 128 000 to 188 000 new jobs created. Coupled with a lower than expected unemployment rate (4.6% vs. 4.7% expected) speculators turned dollar bullish forcing the EUR and GBP exchange rates lower. It goes without saying that this whipsaw was almost certainly caused by those traders who opened positions based on the headline figure alone, and by those who followed this initial burst of momentum. So, trading the data in an economic release requires you to be aware of the full report before opening a position. This leads us nicely to our next point.

Trade What You See, Not What You Think

“So what if the Non-Farm Payrolls data was revised higher for last month, this month's data is terrible. Anyone going long Dollars now is a fool, I'm selling the Dollar across the board. It will move with me again in a minute.” This is the typical chain of thought for any trader who trades what they think and not what they see. In fact some of you reading this may have thought like this on Friday! Be warned, the market is never wrong. Countless individuals (and a few corporations) have lost their shirts because the market was moving in the 'wrong' direction and it 'would turn around at any minute'. As a trader it is your job to follow the market and work with it, even if you think the price action does not reflect the latest fundamentals. (A classic example of this is the dotcom bubble in the late 90s. Many traders correctly identified that the dotcoms were way over valued but began shorting too early. If they had waited for price action confirmation their analysis would have been massively rewarded by the sell-off that eventually took place.) Trading what you see would have allowed you to identify the high momentum reversal (from the post data high of 1.2708 on the EURUSD). Technical traders will know that reversals such as this act as strong resistance. Therefore dollar shorts would represent a riskier position, at least until the resistance had been overcome.

If the price action of Friday the 6th had you completely foxed and you didn't know what you were seeing then the best course of action would be to sit out. It is worth remembering that you never have to trade. The market will be here tomorrow and there will always be another opportunity. As a trader your objective is capital preservation and you cannot achieve this by trading for the sake of it when you are unsure as to what is happening in front of you.

Pinpoint Your Entries and Define Your Risk

Trading what you think may leave you in the mistaken opinion that the market is moving in the 'wrong' direction. In this instance your capital is in great danger unless you define your risk. If the market moves against you and you do not have a stop loss (hard or mental) in place then you cannot cut your losses or move on. The Payrolls price action in question could have been very violent for anybody in this position. Those trading on the headline figure alone could have seen a maximum move against them of 144 and 205 pips on the EURUSD and GBPUSD respectively. Any trader short the dollar, without a stop loss, based on the headline figure of +51k was playing a game of 'catch the falling knives'.

This highlights the need for a trading plan. If you plan your trades, in terms of risk and entry criteria, in advance then there is no need to open positions based on your ego or emotions. If your trade is a loss, it's a loss, time to move on and plan your next trade. If you feel your emotions coming into play then walk away for a while and concentrate on something else. Remember the market will be here tomorrow but your capital might not.

Just Because the Market is Moving Quickly it Doesn?t Necessarily Mean That You Have ToWhen you are learning a new skill and you want to improve you always attempt to work out of your comfort zone. However, the same does not apply to trading. Payrolls data nearly always brings about rapid directional movement. On occasions such as this it is natural to want to jump in early and catch as large a move as you can. Now this is all well and good if you have planned your trade in advance, you know your entry zone and you know where to cut your losses should anything go wrong. If you feel as though you are rushed or forced into making a decision then it will more than likely be against your best interests. For this reason many traders prefer to give the market time to settle down after data releases. This extra time gives the trader an opportunity to assess the direction of the price action and establish new entry points. We can see an example of an opportunity to do this on Friday.

Based on the example of the Non-Farm Payrolls report, Friday 6th of October 2006, here is a recap of the lessons you can learn:

? Non-Farm Payrolls are notoriously volatile
? The figures are highly anticipated by the foreign exchange market which causes massive volatility
? Post data release price action can take the form of a uni directional rally or directionless 'chop'
? Make sure you are aware of all data in a report and not just the headline figure
? Disregarding the news completely and focusing on the price action can remove bias from your trading. Thus, improving your decision making
? Trade what you see, not what you think. The market is always right so don't fight it
? You never have to trade. The market will be here tomorrow but your capital might not
? Never trade based on ego or emotions
? Aim to trade within your comfort zone
? Plan your trades and take your time to identify entry points and define your risk

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David Thorpe is a senior contributor for http://www.passion-trading.munbuns.com a free educational resource centre for traders and investors. The site has a dedicated forextrading and currency trading portal and its goal is to stimulate the minds of its users, enabling them to achieve a greater understanding the forex market, thus helping them to become more profitable.