How to Read a Forex Economic Calendar

A forex economic calendar is useful for traders to learn about upcoming news events that can shape their
fundamental analysis. This piece will explore the DailyFX economic calendar in depth, offering tips on how
to read a forex economic calendar to plan ahead, manage risk, and execute strategic trades.

WHAT IS AN ECONOMIC CALENDAR?

An economic calendar is a resource that allows traders to learn about important economic information
scheduled to be released. Such events might include GDP, the consumer price index, and the Non-Farm
Payroll report. In today’s environment of fiscal cliffs and central bank intervention, it can be very helpful to
know the date of the next central bank meeting or major news announcement.

The events on the calendar are graded low, medium and high, depending on their likely degree of market
impact. This is what the DailyFX economic calendar looks like.

HOW TO READ THE FOREX ECONOMIC CALENDAR

Knowing how to read the forex economic calendar properly is important to maximize your trading prior to
and following the most important releases. Checking the calendar every morning will allow you to familiarize
yourself with the upcoming events that matter.

In default mode, the calendar will show you every piece of economic news coming out for the major
economies. For many, that will be information overload, so you may want to customize the look.
CUSTOMIZING YOUR FOREX ECONOMIC CALENDAR VIEW

In order to customize the economic calendar, you can look at events in the past, today and in the future by
clicking on buttons such as 'Today' 'Tomorrow' and 'Next Seven Days'. It's advisable to change the time
zone to what you’re most comfortable with; this is done by clicking 'Time zone'. For most, this will be Eastern
Standard Time or GMT-4/GMT-5. Next, click the ‘Currencies’ and 'Importance' buttons to look at the events
that are most relevant to you.

For example, if you’re trading EUR/USD and want to focus on today's news coming out of the Eurozone
and United States that is of high importance, your filter would look like this:

Once you select the 'USD' and 'EUR' buttons, you should only see Eurozone and US news
announcements that have a high propensity to move the market should the news surprise traders and
institutions.
As shown in the image above, you can select each event of interest to learn more information about it, the
surrounding news and analysis, and also to add it to your email calendar.

TOP BENEFITS OF USING A FOREX ECONOMIC CALENDAR

The top benefits of using the DailyFX forex economic calendar include:

• Being able to manage risk effectively.

• Being in a position to plan ahead.
• Having access to extra, helpful features for customization.

Risk Management

Being able to plan your trades based on economic calendar events means you can ready yourself for
potential turbulence in price. When an event listed on the calendar occurs, there may be expected a period
of volatility if data is released well above, below or in line with expectations.

Understand the principle of risk management in regard to these trades. Risk is the difference between your
entry price and stop loss price, multiplied by the position size. Traders should aim for this percentage to be
less than 2% of account equity.

Planning Ahead

The forex economic calendar allows for planning ahead. For example, if a Nonfarm Payroll report is set to
be released, traders will know that this indicator has the potential to move FX markets substantially, so
awareness of the timings means they can plan their forex trades accordingly.

Benefiting from Features on the DailyFX Forex Economic Calendar

The forex economic calendar provided by DailyFX offers the added benefit of special features such as the
customization option mentioned above, offering the facility to select specific timeframes, set alerts and
apply filters to make it more relevant to your specific trading strategy.

How to trade Forex News: An Introduction

Major economic data has the potential to drastically move the forex market. It is this very movement, or
volatility, that most newer traders seek when learning how to trade forex news. This article covers the major
news releases, when they occur, and presents the various ways traders can trade the news.

WHY TRADE THE NEWS ON FOREX?

Traders are drawn to forex news trading for different reasons but the biggest reason is volatility. Simply put,
forex traders are drawn to news releases for their ability to move forex markets. ‘News’ refers to economic
data releases such as GDP and inflation, and forex traders tend to monitor such releases considered to be
of ‘high importance’.

The largest moves tend to follow a ‘surprise’ in the data - where the actual data contrasts what was expected
by the market - the good news here is that you don’t have to hold a PhD in Economics because
our economic calendar already provides economist expectations.

Furthermore, news releases are set at pre-determined dates and times allowing traders enough time to
prepare a solid strategy.
Traders that can effectively manage the risks of volatility, at the predetermined time of the news release,
are well on their way to becoming consistent traders.

THE IMPACT OF MAJOR NEWS RELEASES ON THE FOREX MARKET

Just before a major news release, it is common to witness lower trading volumes, lower liquidity and higher
spreads, often resulting in big jumps in price. This is because large liquidity providers, much like retail
traders, do not know the outcome of news events prior to their release and look to offset some of this risk
by widening spreads.

While large price movements can make trading major news releases exciting, it can also be risky. Due to
the lack of liquidity, traders could experience erratic pricing. Such erratic pricing has the potential to cause
a huge spike in price that shoots through a stop loss in the blink of an eye, resulting in slippage.

Additionally, the wider spread could place traders on margin call if there isn’t enough free margin to
accommodate this. These realities surrounding major news releases could result in a short trading career
if not managed properly through prudent money management such as incorporating stop losses or
guaranteed stop losses (where available).

In general, major currency pairs will have lower spreads than the less traded emerging market
currencies and minor currency pairs. Therefore, traders may look to trade the
majors EUR/USD, USD/JPY, GBP/USD, AUD/USD and USD/CAD to mention a few.

Traders need to be well prepared ahead of time – with a clear idea of what events they want to trade and
when they occur. It’s also important to have a solid trading plan in place.

“Don’t think about what the market’s going to do; you have absolutely no control over that. Think about what
you’re going to do if it gets there. In particular, you should spend no time at all thinking about those rosy
scenarios in which the market goes your way, since in those situations, there’s nothing more for you to do.
Focus instead on those things you want least to happen and on what your response will be.” – William
Eckhardt
WHICH MAJOR FOREX NEWS RELEASES TO TRADE?

When learning how to trade news, traders must be aware of the major news events that affect the forex
market, that can be monitored closely using an economic calendar.

US economic data is so influential within global currency markets that it is generally seen as the most
important news. It is important to note that not all news releases lead to increased volatility. Rather, there
are a limited number of major news releases that have previously produced the greatest potential to move
the market.

The table below summarizes the major US economic releases alongside some of the most important non-
US data releases from around the world.

Major news releases (US and rest of world):

ECONOMIC DATA TIME (EST) DESCRIPTION

RELEASE
Non-farm payrolls (NFP) 8:30am – monthly release Represents the net changes in employment jobs
(first Friday after the month
ends)
US Gross domestic 8:30am – quarterly release Gauges the monetary value of all goods and services
product (GDP) produced within the US over a specified period
US Federal 1:00pm – scheduled 8 Interest rate at which depository institutions lend and
Reserve Bank Federal times a year borrow to other institutions, overnight
funds rate
Australian cash rate 10:30pm (First Tuesday of Interest rate charged on overnight loans between financial
the month except January) intermediaries

Australian employment 7:30pm – monthly release Change in number of employed people during the previous
change (about 15 days after month month
ends)
European Central 7:45am – 8 times a year Interest rate on the main refinancing operations offering
Bank refinancing rate liquidity to the financial system
Bank of England official 7:00am – monthly release Interest rate that the BOE lends to financial institutions
bank rate (overnight)

Bank of Canada 10:00am – 8 times a year Overnight rate that major financial institutions borrow and
overnight rate lend between themselves
Canadian employment 8:30am – monthly (about 8 Measures the change in the number of employed people in
change days after month ends) the previous month
Reserve Bank of New 9.00pm – scheduled 7 Interest rate at which banks borrow and lend to other
Zealand official cash times a year banks, overnight
rate
KEY TOOLS & RESOURCES TO TRADE FOREX NEWS

DailyFX provides a one-stop-shop for all your forex related data and news releases:

• Economic calendar: Know when major data like the US Non-Farm-Payroll, GDP, ISM, PPI and CPI
figures are due to be released.
• Central Bank Calendar: Central Bank interest rate decisions can have profound effect on the
financial markets. Get to know when they are scheduled.
• Real time news feed: Stay up to date with breaking news, as it happens, with updates from our top
analysts. Similarly, get all the major stories of the day plus analysis by following our market news.

MANAGING RISK WHEN TRADING NEWS AND EVENTS

The importance of prudent risk management cannot be overstated during volatile periods that follow a news
release.

The use of stops is highly recommended but, in this case, traders may want to consider using guaranteed
stops (where available) over normal stops. Guaranteed stops do come with a fee so be sure to check this
with your broker; however, this fee can oftentimes end up being insignificant in relation to the amount of
slippage that can occur in such volatile periods.

Additionally, traders should also look to reduce their normal trade size. Volatile markets can be a trader’s
best friend but also have the potential to reduce account equity significantly if left unmanaged. Therefore,
in addition to placing guaranteed stops, traders can look to reduce their trade sizes to manage the emotions
of trading.

3 APPROACHES TO FOREX NEWS TRADING

There are a number of approaches traders can adopt when developing a forex news trading strategy
which depend on the timing of the trade relative to the news release.

Many traders like to trade in the moment and make decisions as and when an announcement happens –
using an economic calendar to plan ahead. Others prefer to enter the market in less volatile conditions
ahead of a release or announcement. To summarize, forex news trading fits into one of the categories
below:

1. Trading before the news release

2. Trading on the news release
3. Trading after the news release

1. Trading before the news release

Trading forex news before the release is beneficial for traders looking to enter the market under less volatile
conditions. In general, traders who are more risk averse gravitate towards this approach looking to
capitalize on the quieter periods before the news release by trading ranges or simply trading with the trend.
Discover strategies on how to trade before the news release.

2. Trading during a release

These forex news trading strategies are not for the faint hearted as it involves entering a trade as the news
breaks or in the moments that immediately follow. This is at a time when the market is at its most volatile
which underscores the importance of having a clear strategy and well-defined risk management. Equip
yourself with strategies to navigate the volatility associated with forex news trading at the release.
3. Trading after the news release

Trading post-release involves entering the trade after the market has had some time to digest the
news. Often the market, through price action, provides clues on its future direction – presenting traders with
great opportunity. Learn how to trade the news when the market is in transition with our article on trading
after the news release.

TOP 3 THINGS TO REMEMBER WHEN TRADING NEWS RELEASES

1. Preparation is key: Do not get lured into suddenly trading the news with the rapidly flashing bid
and ask prices on the screen. Be disciplined enough to walk away, reassess and develop a strategy
to be implemented in time for the next major news release.
2. Wider spreads: It is perfectly normal for spreads to widen during major news releases. Ensure
there is enough free margin available to absorb this temporary widening in spread that will require
a greater margin.
3. Volatility: Currency market volatility is a central factor to consider when trading the news. Traders
should consider reducing trade sizes and ensure that stop distances are sufficient to allow for the
anticipated volatility, while at the same time, protecting form any further downside.

TRADING THE NEWS FAQS

How will high importance news releases affect my existing trade?

This will depend mainly on the currency pair and the actual data/figures released. The data will impact the
currency that is directly involved i.e. a change in the interest rate by the European Central Bank (ECB) will
affect any Euro crosses that you hold.

However, currencies trade in pairs so it’s important to be mindful of the strength/weakness of the
accompanying currency. Data that comes out contrary to estimations, tend to make the biggest impact in
the market and these can affect your open trades the most (good or bad).

Looking at this from a swing trader point of view, you may want to consider how close the market is to your
stop or limit prior to the news release. If the market is close to either of those levels it may be best to close
out the trade, there and then. When the market is close to the target, it is better to not risk a lot to gain a
little and when the current price is close to your stop, you may want to cut your losses before they potentially
increase as a result of slippage.

How to trade Before a news release

Trading the ‘news’ before it happens, or in the lead up to an economic data release, is often viewed as less
exciting than the fast-paced environment of trading during or after the release. However, there are many
underutilized opportunities that present themselves during this less volatile period that forex traders can
hunt for. This article will explain how to identify forex trades in the lead up to a news release or
announcement using two specific strategies: pre-release trend following strategy and pre-release calm
strategy.

PRE-RELEASE TREND FOLLOWING STRATEGY

A pre-release trend following strategy focuses on the short-term trend in the lead up to the news release
and requires traders to bring up a daily chart with a 10-day simple moving average (SMA).

Traders are expected to enter the trade before the news, in the direction of the short-term trend; aiming to
ride any increased volatility further in the direction of the trend, after the news has been released.
Additionally, this strategy works if the news results in a low volatility environment as the market is likely to
then continue in the direction of the existing trend.

Traders gravitate towards this strategy when the data to be released is anticipated to be in line with
expectations. Data that comes out in line with expectations generally reduces the impact of the release and
reduces the potential of the news to disrupt the existing trend.

With this strategy, traders have the opportunity of entering at the start of an accelerating trend in order to
capitalize on as much of the advancing market as possible.

The risk when using this strategy arises when the news comes out contrary to expectations which has the
potential to send the market in the opposite direction with increased volatility.

The strategy can be implemented using the following steps:

1. Establish the short-term trend: Use a 10-day moving average to assess whether the market is
in a short-term uptrend (price trading above the 10-day SMA) or in a short- term downtrend (price
trading below the 10-day SMA)
2. Enter the trade: Enter the trade five minutes before the news release in the direction of the trend
3. Manage risk: Set stops and limits while adhering to a positive risk-to-reward ratio
4. Manage the trade: If the volatility created after the news pushes the market quickly towards the
target, traders can consider closing half the position at the target level and moving the stop up to
the target level in the event that there is still more momentum in the market.
PRE-RELEASE CALM STRATEGY

The pre-release calm strategy looks to trade within a range that develops when the market is relatively quite
leading up to the release. Due to the relative lull in the market, traders often overlook this opportunity and
wait to trade after the news when the market is more unpredictable.

The pre-release calm strategy is of a shorter time frame when compared to the pre-release trend strategy,
as you enter and exit before the news is released. Since nobody knows for sure what the data is going to
show, this strategy suits the more risk averse trader – being in and out of the trade before the data has the
opportunity to move the markets in an unfavorable way.

Using a five-minute chart, identify support and resistance levels over the 48 hours prior to the major news
release. Often, in the beginning of the month there are central bank rate announcements before the major
news release of US non-farm payrolls. This strategy can be implemented in the quiet period in between the
announcements and the US non-farm payrolls.

Volume is often light so price will have a tough time pushing through those levels and as a result, the market
can often be described as non-directional (trading in a short-term range).

The pre-release calm strategy can be implemented using the following steps:

1. Adjust chart time frame: Scroll down to the 5-minute chart and observe the 48-hour period before
the news release
2. Analyze the 48-hours prior to release: Identify and draw levels of support and resistance over
the 48-hour period to define the short-term range.
3. Time entries: Traders can look to buy at support and short at resistance, placing stops below
support and above resistance. Targets for long trades can be set at resistance and targets for short
positions can be placed at support.

TRADING THE NEWS BEFORE THE RELEASE: CONCLUSION

Trading before the news release allows traders to enter the market efficiently and at their price when the
market is less volatile. This approach also allows traders the option of trading short term ranges and short-
term trends – providing more opportunity to trade.
However, depending on the importance of the news, it is possible for markets to experience significant
volatility before the release. When this occurs traders should consider a post-release strategy instead.

TRADING THE NEWS FAQS

Sometimes the market is highly volatile leading up to the release, how should I approach this?

When the market is volatile in the lead up to the release, the above strategies are no longer viable. This
underscores the importance of analyzing the market before adopting a strategy. In this scenario it may be
better for traders to monitor the market after the release, once the market has shown its hand and picked
a direction or range to trade in. Learn how to trade forex after the news release.

Trading Forex at the news Release

Trading forex news releases requires a tremendous amount of composure, preparation and a well-defined
strategy. Without these qualities, traders can easily get swept up in all the excitement of a fast-moving
market to their detriment. This article provides useful strategies on how to trade forex news during a major
news release.

FOREX NEWS TRADING STRATEGIES

There are two common strategies for trading forex at the news release:

1. Initial Spike Fade strategy

2. News Straddle strategy

Each one provides a robust plan for traders to follow, depending on the market environment observed at
the time of the release, and how best to approach that particular market.
1. Initial Spike Fade Strategy

This strategy looks to capitalize on an overreaction in the market over the short term by fading the initial
move. This strategy suits reversal traders, scalpers and day traders due to fast moving and erratic pricing
that often follows a major news release.

Overreactions and subsequent reversals are seen fairly regularly in the forex market as large institutions
add to the increased volatility of the initial move. The market as a whole, often spikes as an overreaction
and subsequently push price back toward pre-release levels.

Once the market calms down and spreads return to normal, the reversal often gains momentum showing
early signs of a potential new trend.

The shortfall associated with this strategy is that the initial spike may turn out to be the start of a prolonged
move in the direction of the initial spike. This underscores the importance of using well-defined stops to
limit downside risk and get you out of a bad trade quickly.

How to implement initial spike fade strategy:

1. Select the relevant currency pair: Ensure the major news event corresponds to the desired
currency pair to trade, i.e. Non-Farm Payrolls will affect USD crosses.
2. Switch to a five-minute chart: After selecting the desired market, switch to a 5-minute chart just
before the news release.
3. Observe the close of the first five-minute candle: The first five-minute candle is usually quite
large. When price approaches either the spike high or the spike low, fade the move by trading in
the opposite direction.
4. Stops and limits: Stops can be placed 15 pips above the high for a short trade or 15 pips below
the low for a long trade. Targets can be set at two or three times the distance of the stop.

2. News Straddle Strategy

The news straddle strategy is perfect for traders expecting a huge surge in volatility but are unsure of the
direction. This strategy lends its name from a typical straddle strategy in the world of options trading as it
uses the same core strategy – to capitalize on an increase in volatility when direction is uncertain.
The disadvantage of the news straddle approach surfaces when price breaks support or resistance only to
reverse soon thereafter. Similarly, price can trigger the entry order and move toward your target only to
reverse until a stop it hit.

This strategy can be implemented using the following steps:

1. Establish a range with support and resistance.

2. Set two orders to open: Set a working order/ entry order to open a long trade if price breaks
above resistance and one to go short if price trades below support.
3. Remove remaining order after confirming direction: The market has the potential to breakout
of the range and once this happens, the one entry order will be triggered, and a trade will be
opened. Immediately remove the entry order that was not triggered.
4. Stops and limits: A tight stop can be placed at the recent range low when going long and recent
high when going short. Limits can be placed in line with a positive risk to reward ratio.

TRADING THE NEWS DURING THE RELEASE: CONCLUSION

Trading forex news at the news release has the potential to overwhelm traders with increased volatility in a
short period of time. However, through the adoption of a solid strategy, traders can approach these volatile
periods with greater confidence and mitigate risk of a runaway market through the use of guaranteed stops
(where available).

TRADING FOREX NEWS RELEASES FAQS

How can I tell which direction the market will trade after at the release?

Forecasting the economic news release is one thing, predicting how traders will react to the news release
is quite difficult. When estimations are unsurprising or more or less similar to the previous recorded number,
the market tends to digest this information and it is reflected in the lead up to the release. However, there
is no guarantee that the market direction/trend will be maintained even if the news comes out exactly as
was estimated. This is because different market participants can draw different conclusions that will
influence their trades.

Someone may consider data that prints in line with expectations as a bad thing and someone else may
view it as a good thing. The bottom line is that traders need to have a strategy in place with predetermined
risk parameters.
How to trade after a news Release Writer

Traders need to learn how to navigate volatile markets by implementing a solid trading plan and adopting
sound risk management. This article provides effective tools for traders looking to trade post release.

POST-RELEASE TRADING STRATEGIES

1. Trend following strategy

This strategy involves the use of multiple time frames, as well as, well-defined levels of support and
resistance that come into play after a news release.

Traders can adopt this strategy when the current market price is approaching a well-defined level of support
or resistance but isn’t quite there yet. The volatility after the news release has the potential to push the
market toward the trendline. If price respects the trendline, traders can look to trade in the direction of the
trend and trade the potential bounce.

The following 4 points are of assistance for this type of trade:

1. Determine trend direction on a daily chart

2. Draw support and resistance lines
3. Select a forex time frame anywhere from 1 – 4 hours
4. Buy near support in uptrend and sell near resistance in downtrend

Keep in mind that news releases have the potential to break through longstanding levels of support and
resistance which underscores the importance of using tight stops when pursuing this strategy.
2. Dual spike breakout strategy

This strategy involves waiting for market volatility to reveal a range before trading a break of that range and
makes use of a five-minute chart. For illustrative purposes this section incorporates the US Non-Farm
Payroll (NFP) release as this often has the greatest potential to move the market.

After the NFP release, wait 15-minutes for three five-minute candles to close. Take note of the highest price
and the lowest price of the three closed candles. Next, place an entry order to go long at the highest price
and an entry to go short at the lowest price. Once an order is triggered, targets can be set at twice the
distance of the high/low channel while stops can be set above resistance for short trades and below support
for long trades.

The disadvantage of this strategy is that volatility can push price above or below the short-term range,
triggering an entry order, and then immediately reversing to hit a stop loss.

This strategy can be applied in the following way:

1. Customize the chart settings to show 5- minute charts

2. Take note of the highs and lows of the first three candles
3. Set entry orders when price breaks above or below the range
4. Set stops and limits
5. Delete the unfilled order
Dual spike forex news trading strategy

3. News Reversal Strategy

The market can trade in one direction immediately after a major news release only to reverse and trade in
the opposite direction.

The news reversal strategy looks to trade the news after the release and focuses on a sudden, sustained
reversal in direction after a strong initial move in price.

The reversal could be the result of algorithms or, the market as a whole, feeling that there was an
overreaction in price – prompting trades in the opposite direction.

The downside of this strategy is that no reversal takes place and the price continues trading in the
direction on the initial spike.

How to implement the news reversal strategy:

1. Initial spike in price: News with great market moving potential generally lead to a spike in price
as the news is released.
2. Look out for a reversal: Traders can wait 10-15 minutes for the reversal to bring price back to
where it was before the release.
3. Entry: Enter as price breaks above/below pre-release levels.
4. Set multiple target levels: Traders should consider setting multiple target levels. As one is
triggered, traders can take profit on half of the position and adjusting the stop on the remaining
position to breakeven.

TRADING FOREX AFTER THE RELEASE: CONCLUSION

Trading the news after the release can be a more conservative way to approach news trading. This is due
to the emotions from the news release subsiding allowing a trader time to plan a technical set up for their
trade. Regardless of your trading approach to news trading, risk management and utilizing small amounts
or no leverage is critical to maintaining capital in your account to make the next trade.

BOOST YOUR FOREX TRADING KNOWLEDGE

• Download our free currency forecasts to stay abreast with the DailyFX expert view on forex market
movements.
 • If you’re just starting out on your forex trading journey, download our free New to Forex trading
guide to get to grips with the basics.

TRADING AFTER THE NEWS FAQ SECTION

What type of news is most likely to move the market?

US economic data is so influential within global currency markets that it is generally seen as the most
important news. Additionally, it is important to note that not all news releases lead to increased volatility.
Rather, there are a limited number of major news releases that have previously produced the greatest
potential to move the market and some of these include:

• US non-farm payrolls
• US GDP
• Us Federal Funds Rate announcement
• ECB refinancing rate
• Australian employment change

How Fundamentals Move pries in FX Market

TALKING POINTS:

• Fundamental Analysis in the Currency markets centers around Macroeconomic data

• Macroeconomic analysis can be simplified by focusing on interest rates (and expectations)
• Traders can incorporate Price Action to make analysis even more simplistic

Fundamental Analysis in the stock market involves analyzing the inputs of a company in an effort to forecast
future growth potential. For an individual company, this can be a very logical way to look for investment
ideas. Fundamental Analysis of a company would involve investigating that company’s financial statements,
to notice changes from one year to the next; or perhaps looking that the management of that company, and
their track record in order to determine how successful they might be towards accomplishing their goals.

In the Forex market, many of those statistics don’t exist, and we’re trading entire economies against one
another. In each of these economies, thousands of companies exist trying to maximize their profit potential,
so the analysis of a single company’s management structure or market share doesn’t really mean a whole
lot.

Due to the nature of the market, many traders refer to technical analysis, and we showed you how
fundamental data events can be traded with technical analysis in the article The Potent Combination of
Fundamentals and Price Action. In this article, we’re going to go in-depth behind how fundamentals impact
prices in the FX market.

WHY CURRENCY VALUES MATTER

Currency prices matter because of cross-border trade. We investigated this concept in-depth in The
Nucleus of the FX Market. In the article, we saw how the nation of Japan was absolutely ravaged by a
strong yen; as a stronger yen meant lower profits and margins for Japanese exporters.

The concept of Fundamental Analysis in the Forex Market can be all boiled down to one simple data
point: Interest Rates. If interest rates move higher, investors have a greater incentive to invest their
capital; and if interest rates move lower, that incentive is lessened. This relationship is at the heart and
soul of macroeconomics; and this is what allows Central Bankers to have tools to steward their respective
economies.

The decision to increase or decrease rates can bring impact to other economies as well. Let’s say, for
instance, that you are an American with cash to invest. After having little incentive and extremely low rates
for a long time, you notice that The United Kingdom increases rates 25 basis points. This increase in interest
rates from the Bank of England can and should bring higher rates in other issues from The United Kingdom;
so you may not necessarily buy Gilts or a government bond, but investors can now look to invest in England
to get that higher rate of return.

Additional investors thinking the same thing rush into UK bonds, and eventually – the price of the British
Pound will go up to reflect this additional demand. Now it becomes slightly more difficult for the UK to export
goods (similar to the problem Japan faced in The Nucleus of the FX Market).

A great example of this was in Australia from 2002 leading up to the Financial Collapse; as insatiable
demand from China drove growth throughout Australia, unemployment got very low and inflation moved
very high. The Reserve Bank of Australia (RBA) moved to increase interest rates, and currency prices
followed.

THE AUSSIE MORE THAN DOUBLED WHILE RBA MOVED RATES FROM 4.25% TO 6.75%
This is an interest rate cycle, and it drives capital flows that are at the heart of the FX market.

HOW INTEREST RATE CYCLES DRIVE ECONOMIES

It all goes back to the incentive to invest. If Central Bankers want to slow down their economy, they look to
raise rates. If they want to encourage more growth within an economy, they look to decrease rates.

Higher or lower rates bring a two-pronged impact on the economy.

The first and most obvious impact is the incentive to invest. If rates increase, that incentive to invest also
increases; and if rates decrease, so does the incentive to lock up one’s money.

The second impact is what this does for capital expenditures. If rates decrease, the attractiveness of locking
up a long-term loan at the new lower rate is much higher than it was previously. The incentive to buy big-
ticket items like homes, and cars is now higher.

And when you buy a home or a car, the homebuilder or car maker has to turn around to pay for their
materials and workers. If the lower rates increase the number of homes or cars that are being purchased,
this amounts to growth. Homebuilders and car makers will eventually have to hire new workers to keep up
with the demand; and as demand for workers increases, so will the wages that are needed to attract
qualified candidates.

This is how lower interest rates can bring higher employment and inflation (often shown as CPI or
‘Consumer Price Index’); and it’s at this point that Central Bankers are going to investigate increasing rates
in an effort to prevent the economy from over-heating.

If interest rates stay low, the effects of ‘over-heating’ could be immense. Prices can continue inflating, and
if left unchecked – could bring hyperinflation.

Imagine going to the store to buy a gallon of milk and seeing the price at 27 dollars. I don’t know about you,
but I’d freak out at seeing something like this. Then my mind would wander to other areas where costs
might be increasing. If a gallon of milk is 27 dollars, then how much will that new car cost me? How much
is milk going to cost tomorrow?

So, Central Banks want a moderate rate of inflation. This helps to keep growth within an economy; people
get pay increases, more people are working and paying taxes, and consumers have the confidence that
they can save their money for tomorrow because prices won’t increase a hundred-fold overnight.

WHAT DO CENTRAL BANKERS WATCH?

Both Central Bankers and Forex Traders watch macroeconomic data prints with the goal of getting
something out of them; but their objectives are slightly different.

FX Traders are often interested in the price reaction of a data print. If CPI comes out higher than expected,
then traders may be looking for long positions to move higher.
FX TRADERS CAN PRICE IN NEW DATA QUICKLY, CREATING VOLATILE PRICE MOVEMENTS

Created with Market scope/Trading Station II

Central Bankers, however, take a much broader view on such statistics.

Central Bankers want to watch the primary points of reference for an economy in an effort to make the
correct decision as to where to move rates.

Inflation and employment are chief amongst these statistics, as these are two of the primary pressure points
within an economy. If unemployment is high, the economy will likely struggle. As
employment/unemployment prints are released out of an economy, this new information is factored in fairly
quickly. FX Traders will begin pricing this in with the probability of an eventual rate hike or cut by Central
Bankers to factor this information in.

Same for inflation: As inflation (CPI) data prints are released in an economy, traders will act quickly to
incorporate this new information in to prices. Meanwhile, Central Bankers are watching cautiously to
decide if they want to do anything at their next meeting.

Increasing unemployment (decreasing employment) along with decreasing inflation are threats to an
economy that will usually see Central Bankers investigate rate cuts.

Decreasing unemployment (increasing employment), and increasing inflation are signs of a growing
economy, and this is when Central bankers will look at potential rate hikes.

But, Central Bankers and Forex traders alike are not happy to just sit around and wait for employment or
inflation numbers to show changes within an economy. This has brought to light numerous additional data
prints that traders and investors will look to in an effort to anticipate changes to inflation, unemployment
and interest rates.

Consumer statistics are extremely important in large economies like The United States, or Europe in which
consumer activity has a heightened level of importance for the global economy. In the article, The Lifeblood
of the US Economy, we looked at the major data releases that include this information. The Euro can get
extremely volatile around releases of Consumer Sentiment Numbers, and this is because consumer activity
in established economies is often looked at as a precursor to inflation, employment, and growth.
GDP, or Gross Domestic Product, is a direct expression of growth (or contraction) within an economy, and
this can also be a huge precursor to price movements; especially if the announced rate of growth is far
away from expectations. But, in and of itself, increases or decreases in GDP don’t bring more jobs or higher
inflation, so this is often looked at as more of a ‘lagging’ fundamental indicator.

Production numbers can be especially important in growing economies that are at a very industrialized
stage of the growth process. China is a phenomenal example; as each month ‘PMI’ (Purchasing Managers
Index), will draw massive interest from numerous parties around the globe.

PMI is a survey that’s recorded from producers gauging their sentiment on future orders. The thought
behind this statistic is that if producers are seeing growth, then that growth will eventually cycle through to
consumers; after all, if someone wants to buy a good, it has to be produced in the first place, right?

BULLISH DATA BEARISH DATA

Higher GDP Lower GDP
Higher Inflation Lower Inflation
Higher Employment Lower Employment
Lower Unemployment Higher Unemployment
Higher Consumer Confidence Lower Consumer Confidence
Higher PMI Lower PMI

Regardless of the data print or release, the market’s reaction always comes back to interest rate cycles,
and how that improvement or decline in measured activity might eventually amount to an interest rate
increase or decrease.

HOW TO TRADE FUNDAMENTALS

A line that I used in The Potent Combination of Fundamentals and Price Action is a line that I say quite a
bit in webinars and live events:

‘Not only do you not know what any given data print might be, but you aren’t entirely sure of how the
market might price it in.’

This makes trading on fundamentals in the FX market dangerous; because you could guess that GDP is
going to come out better than expected, and you can trade it accordingly and still eat a stop. You can be
right, and still lose.

In stocks, trading on fundamentals makes a lot of sense. You can grade company A versus company B in
relevant markets. You’re trading one small part, of one economy, in the larger global macroeconomic
environment.

The market capitalization of any company that you’re trading might be a few hundred billion, at most. The
currency market turns over north of $5,000,000,000,000 every day. That’s 5 trillion, and this is on the low-
side of estimates.

You’re trading entire economies against each other, and it can be much more difficult to use fundamental
points of reference in an effort to project future growth potential.

For this reason, many traders in the FX market incorporate or include Technical Analysis in their
fundamental trade ideas. This can bring quite a bit of benefit to the trader in helping to determine trends or
biases that may have been exhibited in a currency.
HOW TECHNICAL ANALYSIS CAN IMPROVE YOUR FUNDAMENTAL APPROACH

Earlier in the article, we used the hypothetical example of the Bank of England increasing interest rates 25
basis points. When this happens, we’ll generally see traders buying the British Pound to get this new, higher
rate.

But, it’s not only rate hikes that will see buying the Forex market; as traders don’t want to wait around to
see a Central Bank do what they know that they’ll probably do anyways.

So, as we see increasingly positive data coming from the UK; data that may eventually amount to an interest
rate increase, we’ll see increased demand for the British Pound. This increased demand will show higher
prices.

So, this is a fundamental theme – that is clear and apparent in the technical setup of the chart. If there is
an up-trend, prices are moving higher for a reason, right?

PRICES CAN SHOW BIASES AND TRENDS IN FUNDAMENTAL DATA

Taken from The Potent Combination of Fundamentals and Price Action

Traders can incorporate price action to see where these trends may be existing, and to what degree they
might be traded. Then, traders can also use price action to buy up-trends cheaply, and sell down-trends
expensively; so that if that momentum continues, they can look to profit.

If you’d like to get more familiar with price action, our capstone article is a great way to get started.

FUNDAMENTAL ANALYSIS FAQS

What moves the FX market more: interest rate expectations or interest rate announcements?

FX traders and large institutional traders look for clues about interest rates and trade accordingly. If the
expectation is that rates will increase and the expectation is widely adopted, the currency in question will
rise in value even before the announcement is made. This phenomenon is why expectations are often
referred to as the Driver of Forex Rates.
What is Monetary Policy and how does this affect exchange rates?

Central banks perform an essential role as they seek to maintian stability in the financial system. Most
central banks operate according to a mandate that focuses on inflation, GDP growth, unemployment or a
combination of these. Through changing the interest rate, a reserve bank can have a ripple effect in the
forex market. This is why it is essential for traders to know and understand central bank Policy and Market
Effects. At DailyFX we run a Central Bank Weekly webinar focusing on major central banks and upcoming
announcements.

A Guide to GDP and Forex trading

GDP (Gross Domestic Product) economic data is deemed highly significant in the forex market. GDP
figures are used as an indicator by fundamentalists to gauge the overall health and potential growth of a
country. Consequently, greater volatility in the forex market is closely observed during the GDP release.

WHAT FOREX TRADERS NEED TO KNOW ABOUT GDP

What is GDP?

Developed in 1934 by Simon Kuznets, the Gross Domestic Product (GDP) measures the output and
production of finished goods in a country’s economy. Usually, GDP is measured in three different time
periods: monthly, quarterly and annually. This enables economists and traders to get an accurate picture
of the overall health of the economy.

There are many approaches to calculating GDP, however, the US Bureau of Economic Analysis uses the
“Expenditure Approach” using the formula:

GDP = Consumption (C) + Investment (I) + Government Spending (G) + (Exports (X) - Imports (M))

Understanding the relationship between GDP and the forex market

The general rule of thumb when looking at GDP data is looking at whether figures beat or fall below
estimates (see relevant charts below):
 • A lower than projected GDP reading will likely result in a sell off of the domestic currency relative
to other currencies (USD depreciating against EUR).

EUR/USD chart: Low GDP data release

• A higher than projected GDP reading will tend to strengthen the underlying currency versus other
currencies (USD appreciating against EUR).

EUR/USD chart: High GDP data release

GDP reports do not always have the same or expected effect on currencies. This is important to keep in
mind before committing to a trade. Often, GDP figures are already fully/partially priced into the market
meaning that the market may not react as anticipated once GDP figures are released.

Related economic data reports regularly allow for the market to ascertain a somewhat accurate estimate.
Data to look out for:
 • ISM data
• PPI data

ANALYSING GDP DATA TO INFORM CURRENCY TRADING DECISIONS

GDP, Inflation and Interest Rates

The advance release of GDP is four weeks after the quarter ends while the final release happens three
months after the quarter ends. Both are released by the Bureau of Economic Analysis (BEA) at 08:30 ET.
Typically, investors are looking for US GDP to grow between 2.5% to 3.5% per year.

Without the specter of inflation in a moderately growing economy, interest rates can be maintained around
3%. However, a reading above 6% GDP would show that the US economy is endanger of overheating
which can, in turn, spark inflation fears.

Consequently, the Federal Reserve may have to raise interest rates to curb inflation and put the ‘brakes’
on an overheating economy. Maintaining price stability is one of the jobs of the Federal Reserve. GDP must
stay in a ‘goldilocks range’: not too hot and not too cold.

GDP should not be high enough to trigger inflation or too low where it could lead to recession. A recession
is defined by two consecutive negative quarters of GDP growth. The GDP ‘sweet spot’ varies from one
country to another. For example, China has had GDP in double digits.

Forex traders are most interested in GDP as it is a complete health report card for a country’s economy. A
country is ‘rewarded’ for a high GDP with a higher value of their currency. There is usually a positive
expectance for future interest rate hikes because strong economies tend to get stronger creating higher
inflation. This, in turn, leads to a central bank raising rates to slow growth and to contain the growing specter
of inflation.

On the other hand, a country with weak GDP has a drastically reduced interest rate hike expectation. In
fact, the central bank of a country that has two consecutive quarters of negative GDP may even choose to
stimulate their economy by cutting interest rates.

TRADING CURRENCY PAIRS USING GDP DATA

Quarter-on-quarter figures tend to produce much more variable changes in the overall trend – e.g. Positive
GDP figures beating estimates QoQ may be fleeting when taking into consideration year-on-year (YoY)
data. YoY data allows for a broader perspective which could potentially highlight an overall trend.

The chart below shows a longer time frame EUR/USD view as seen in Chart 2 above. This chart expresses
the variation in short term QoQ data against the longer-term YoY trend.
GDP AND ECONOMIC DATA: TOP TIPS FOR FX TRADERS

• If you’re new to forex trading, our New to Forex trading guide covers all the basics to help you on
your journey.
• CPI is released monthly by most major economies to give a timely glimpse into current growth and
inflation levels.
• Fundamental traders monitor economic data releases, and many do so with the intention of trading
the news. It is essential that traders adopt sound risk management when doing so as volatility can
spike immediately after important releases.

The CPI and Forex: How CPI data affects Currency pairs

In this article, we’ll explore CPI and forex trading, looking at what traders should know about the Consumer
Price Index to make informed decisions. We’ll cover what CPI is as a concept, the CPI release dates, how
to interpret CPI, and what to consider when trading forex against CPI data.

WHAT IS CPI AND WHY DOES IT MATTER TO FOREX TRADERS?

The Consumer Price Index, better known by the acronym CPI, is an important economic indicator released
on a regular basis by major economies to give a timely glimpse into current growth and inflation levels.

Inflation tracked through CPI looks specifically at purchasing power and the rise of prices of goods and
services in an economy, which can be used to influence a nation’s monetary policy.

CPI is calculated by averaging price changes for each item in a predetermined basket of consumer goods,
including food, energy, and also services such as medical care.

It is a useful indicator for forex traders due to its aforementioned effect on monetary policy and, in turn,
interest rates, which have a direct impact on currency strength. The full utility of knowing how to interpret
CPI as a forex trader will be explored below.

CPI RELEASE DATES

CPI release dates usually occur every month, but in some countries, such as New Zealand and Australia,
quarterly. Some nations also offer yearly results, such as Germany’s index. The US Bureau of Labor
Statistics has reported the CPI monthly since 1913.
The following table shows a selection of major economies and information about their CPI releases.

COUNTRY/JURISDICTION COMPILING BODY FREQUENCY OF

RELEASES

Australia Australian Bureau of Statistics Quarterly

Canada Statistics Canada Monthly

China National Bureau of Statistics of China Monthly

Eurozone European Central Bank Twice monthly

Germany Federal Statistical Office of Germany Monthly, yearly

Italy Istat Monthly

India Ministry for Statistics and Programme Monthly

Implementation

Japan Statistics Japan Monthly

UK Monetary Policy Committee Monthly

US US Bureau of Labor Statistics Monthly

WHY FOREX TRADERS SHOULD FOLLOW CPI DATA

Understanding CPI data is important to forex traders because it is a strong measure of inflation, which in
turn has a significant influence on central bank monetary policy.

So how does CPI affect the economy? Often, higher inflation will translate to higher benchmark interest
rates being set by policymakers, to help dampen the economy and subdue the inflationary trend. In turn,
the higher a country’s interest rate, the more likely its currency will strengthen. Conversely, countries with
lower interest rates often mean weaker currencies.

The release and revision of CPI figures can produce swings in a currency’s value against other currencies,
meaning potentially favorable volatility from which skilled traders can benefit.

Also, CPI data is often recognized as a useful gauge of the effectiveness of the economic policy of
governments in response to the condition of their domestic economy, a factor that forex traders can
consider when assessing the likelihood of currency movements.

The CPI can also be used in conjunction with other indicators, such as the Producer Price Index, for forex
traders to get a clearer picture of inflationary pressures.

WHAT TO CONSIDER WHEN TRADING FOREX AGAINST CPI DATA

When using CPI data to influence forex trading decisions, traders should consider the market expectations
for inflation and what is likely to happen to the currency if these expectations are met, or if they are missed.
Similar to any major release, it may be beneficial to avoid having an open position immediately before.
Traders might consider waiting for several minutes after the release before looking for possible trades,
since forex spreads could widen significantly right before and after the report.

Below is a chart displaying the monthly inflation rates for the US. For the latest month, expectations are set
at 1.6% inflation compared to last year’s data. If CPI is released higher or lower than expectations this news
event does have the ability to influence the market.

Chart to show US inflation levels in 2018/19. Source: [Link]. US Bureau of Labor Statistics

One way the effects of CPI data can be interpreted is by monitoring the US Dollar Index, a 2018/19 example
chart for which is below. If CPI is released away from expectations, it is reasonable to believe this may be
the catalyst to drive the Index to fresh highs, or to rebound from resistance.

Since the Index is comprised of EUR/USD, USD/JPY, and GBP/USD, by watching the US Dollar we can
get a full interpretation of the events outcome.

Chart to show movement in the US Dollar Index. Source: [Link]

As can be observed in the example above, as inflation rose during the first half of 2018, the US Dollar Index
went up accordingly. But with US inflation drifting lower in the following months and with a missed target of
2%, this pushed US interest rate hikes off the agenda. As a result, the dollar struggled and weakened
against a basket of other currencies.

Not every fundamental news release works out through price as expected.
Once the CPI data has been released and analyzed, traders should then look to see if the market price is
moving through or rebounding off any areas of technical importance. This will help traders understand the
short-term strength of the move and/or the strength of technical support or resistance levels, and help them
make more informed trading decisions.

READ MORE ON CPI, INFLATION AND FOREX

Make sure you bookmark our economic calendar to stay tuned in to the latest CPI data released by a range
of countries, and stay abreast of all the DailyFX news and analysis updates.

For more information on inflation and its impact on forex decisions, take a look at our article Understanding
Inflation for Currency Trading.

How to use PPI in forex trading. the PPI in Forex Trading

USING PPI TO TRADE FOREX: TALKING POINTS

• PPI stands for the Producer Price Index, which is an important piece of economic data
• PPI data is released during the second week of each month.
• Forex traders can use PPI as a leading indicator to forecast consumer inflation measured by the
Consumer Price Index (CPI).

PPI is an important piece of economic data due to it’s signaling effect on future expected inflation. Traders
monitor PPI in forex trading because of the positive relationship between inflation and interest rates, but
ultimately, traders are concerned with how the resultant interest rate changes are likely to affect currency
pairs. Continue reading to learn more about the PPI index and how it affects the foreign exchange market.

WHAT IS PPI AND WHAT DOES IT MEASURE?

PPI stands for Producer Price Index and measures the change in the price of finished goods and services
sold by producers. PPI data represents the monthly change in the average price of a basket of goods
purchased by manufacturers.

How is PPI calculated?

PPI examines three production areas; commodity-based, industrial-based, and stage-of-processing-

based companies. Released by the Bureau of Labor Statistics, PPI is created using data collected from a
mailed survey of retailers selected via a process of systematic sampling of all firms listed with the
Unemployment Insurance System.

Traders can see changes in PPI expressed as a percentage change from the previous year, or on a
month-to-month basis.

PPI and inflation

A positive change in the PPI index implies that costs are rising and, in the end, price increases get passed
down to consumers. If this effect is large enough, there will be an increase in future CPI figures to reflect
that the general level of prices has increased.

Inflation and the effect on the economy

An increase in the general price level is good for an economy but only when this is contained. When demand
for goods and services increases, businesses must increase capital expenditure and hire more workers in
order to increase their output to meet higher demand. The problem arises when prices increase drastically,
resulting in a decrease in the purchasing power of a country’s currency. $1 can buy less than it could one
year ago, for example.

In the 1950s, gasoline was $0.27, while apartment rent was $42/month and a movie ticket was $0.48. These
figures are nowhere near to where they are today, and this reflects how inflation erodes the value of local
currency. In an attempt to combat the erosion of purchasing power, central banks effectively reduce inflation
by raising the benchmark interest rate.

HOW DOES PPI IMPACT CURRENCIES?

When it comes to money there is always a trade-off: individuals can save money and earn interest, or they
can spend money immediately and forgo any interest payments.

If PPI is on the rise it may cause the interest rates to rise. When interest rates go up, electing to save money
looks more attractive as the reward (interest) is greater than before. Spending money becomes costlier
because consumers would effectively be losing out on the higher interest rate when they choose to spend
money instead of saving. As a result, increased PPI may filter down into increased rates and a stronger
currency.
Using the Euro as an example, forex traders know that higher interest rates results in increased financial
flows by foreign investors wanting to buy the higher yielding Euro. This effect tends to drive the value of the
Euro up as the demand for the Euro has increased.

A popular strategy chasing higher interest rates is the “carry trade” strategy; whereby traders borrow funds
in a currency that has a low interest rate and buy a currency with a higher interest rate.

Money follows yield and traders will look to take advantage of this.

HOW PPI AFFECTS THE US DOLLAR

The Producer Price Index tends to have little effect on the US dollar initially. This is because in the real
economy there is a time lag between the increase in prices from producers, and the end result of higher
inflation resulting from consumers having to fork out more at the tills.

However, don’t be misled by the “low priority” impact assessment of this data release. Astute traders are
able to forecast the knock-on effects PPI is likely to have on CPI and interest rates and trade accordingly.
Thus, the most valuable component of the PPI data is the signaling effect it provides to the market.

LEARN MORE ABOUT FUNDAMENTALS IN FOREX TRADING

• Other important fundamental data includes: CPI, ISM, non-farm payroll statistics and GDP.
Traders should have a solid understanding of each of these statistics and what they mean for the
forex market.
• Fundamental analysis is just one of the 3 types of forex analysis used by traders, and can be
invaluable when predicting long term movements and trends.
• Keep up to date with crucial data releases happening this week via our economic calendar.
• Data releases have the ability to make significant moves in the FX market but with increased
volatility it is important to manage your risk accordingly by learning how to trade the news.
How Forex trader Use ISM Data

The ISM manufacturing index plays an important role in forex trading, with ISM data influencing currency
prices globally. As a result, the ISM manufacturing, construction and services indicators can provide unique
opportunities for forex traders, which makes understanding this data (and how to prepare for its monthly
release) essential.

Talking points:

• What is ISM?
• How ISM impacts currencies
• How forex traders use ISM data

WHAT IS ISM?

The Institute for Supply Management (ISM) measures the economic activity from both the manufacturing
side as well as the service side. Monthly ISM data releases include key information such as changes in
production levels.

ISM was formed in 1915 and is the first management institute in the world with members in 300 countries.
The data gleaned from its large membership of purchasing managers means ISM is a reliable guide to
global economic activity, and as a result, currency prices. A country’s economy is often determined by its
supply chain, as a result, the monthly ISM manufacturing and non-manufacturing PMI economic news
releases are carefully watched by forex traders around the world.

ISM Surveys

ISM publishes three surveys - manufacturing, construction, and services – on the first business day of every
month. The ISM Purchasing Managers Index (PMI) is compiled from surveys of 400 manufacturing
purchasing managers. These purchasing managers from different sectors represent five different fields:

1. Inventories
 2. Employment
3. Speed of supplier deliveries
4. Production level
5. New orders from customers.

In addition, ISM construction PMI is released on the second business day of the month, followed by services
on the third business day. Forex traders will look to these releases to determine the risks at any given time
in the market.

HOW DOES ISM IMPACT CURRENCIES?

The Manufacturing and Non-manufacturing PMIs are big market movers. When these reports are released
at 10:30am ET, currencies can become very volatile. Since these economic releases are based on the
previous month’s historical data gathered directly from industry professionals, forex traders can determine
if the US economy is expanding or contracting - much like non-farm payrolls (NFP) data.

Currencies react with this information as it represents a gauge of US economic health (see image below).

Source: Institute for Supply Management

HOW FOREX TRADERS USE ISM DATA

Forex traders will compare the previous month’s ISM data figure with the forecasted number that
economists have published. If the released PMI number is better than the previous number and higher than
the forecasted number, the US dollar tends to rally. This is where fundamental and technical
analysis comes together to create a trade setup.

EUR/USD drops as a result of better-than-expected data

In the example above, notice how the better-than-expected PMI number triggered a US dollar rally against
the Euro. As seen in the chart (EUR/USD – one hour), the ISM Manufacturing PMI came in higher than the
previous month at 54.9.

When an economic release beats expectation, sharp fast moves can ensue. In this case,
EUR/USD dropped 150 pips in a few hours. Traders often choose the Euro as the “anti-dollar” to take
advantage of capital flows between two of the largest economies.

The Eurozone has large liquid capital markets which can absorb the huge waves of capital seeking refuge
from the US. A weak US ISM Non-Manufacturing number usually leads to a dollar sell-off and a rise in
the Euro. Another scenario is when the number released is in line with forecasts and/or unchanged from
the previous month, then the US dollar may not react at all to the number.

Overall, an ISM PMI number above 50 indicates that the economy is expanding and is healthy. However,
a number below 50 indicates that the economy is weak and contracting. This number is so important that if
the PMI is below 50 for two consecutive months, an economy is considered in recession.

PMIs are also compiled for Euro zone countries by the Markit Group while US regional and national PMIs
are compiled by ISM. As you can see, traders have good reason to pay special attention to the important
releases from the ISM manufacturing index.

LEARN MORE ABOUT FOREX FUNDAMENTALS

• Take note of other key fundamental releases such as Consumer Price Index (CPI), Producer
Price Index (PPI) and Non-Farm Payrolls (NFP).
• Keep an eye on DailyFX market news for the latest updates on currency prices, or bookmark
our economic calendar to prepare for upcoming events.
• Our live trading webinars cover various topics related to the forex market like PMI data, currency
news, and technical chart patterns.
• We also recommend viewing our Traits of Successful Traders guide to discover the secrets of
successful forex traders.
NFP and Forex: What is NFP and How to trade it.

NFP and Forex Trading: MAIN TALKING POINTS

• Non-Farm Payrolls (NFP) releases create volatility in the forex market.

• NFP measures net changes in employment jobs.
• Forex traders use an economic calendar to prepare for NFP releases.

What is the NFP?

The non-farm payroll (NFP) figure is a key economic indicator for the United States economy. It represents
the number of jobs added, excluding farm employees, government employees, private household
employees and employees of nonprofit organizations.

HOW DOES THE NFP AFFECT FOREX?

NFP data is important because it is released monthly, making it a very good indicator of the current state
of the economy. The data is released by the Bureau of Labor Statistics and the next release can be found
on an economic calendar.

Employment is a very important indicator to the Federal Reserve Bank. When unemployment is high, policy
makers tend to have an expansionary monetary policy (stimulatory, with low interest rates). The goal of an
expansionary monetary policy is to increase economic output and increase employment.

So, if the unemployment rate is higher than usual, the economy is thought to be running below its potential
and policy makers will try to stimulate it. A stimulatory monetary policy entails lower interest rates and
reduces demand for the Dollar (money flows out of a low yielding currency). To learn exactly how this works,
see our article on how interest rates effect forex.

The chart below shows how volatile forex can be after an NFP release. The expected NFP results for March
8, 2019 were 180k (job additions), the actual result disappointed with only 20k jobs being added. As a
result, the Dollar Index (DXY) depreciated in value and volatility increased.
Forex traders must be wary of data releases like the NFP. Traders could get stopped-out due to the sudden
increase in volatility. When volatility increases, spreads do too, and increased spreads can lead to margin
calls.

WHICH CURRENCY PAIRS ARE MOST AFFECTED BY NFP?

The NFP data is an indicator of American employment, so your currency pairs that include the US
Dollar (EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF and others) are most affected by the data
release.

Other currency pairs also display an increase in volatility when the NFP releases, and traders must be
aware of this as well, because they may get stopped out. The chart below shows the CAD/JPY during the
NFP data release. As you can see, the increase in volatility could stop a trader out of their position even
though they are not trading a currency pair linked to the US Dollar.

NON-FARM PAYROLL RELEASE DATES

The Bureau of Labor statistics normally releases the NFP data on the first Friday of each month at 8:30 AM
ET. The release dates can be found on the Bureau of Labor Statistic’s website.

Due to the volatile nature of the NFP release, we recommend using a pull-back strategy rather than a
breakout strategy. Using a pullback strategy, traders should wait for the currency pair to retrace before
entering a trade.

Using the same example as above (NFP results 20k vs 180k expected) we expect the US Dollar to
depreciate. In the example below, we use the EUR/USD. Because the NFP data came out worse than
expected, we forecast the EUR/USD to appreciate.
TRADING THE NFP DATA RELEASES: TOP TIPS & FURTHER READING

Here are a few tips to remember when using NFP data releases to inform your forex trading:

1. NFP data is released on the first Friday of every month.

2. The NFP data release is accompanied with increased volatility and widening spreads.
3. Currency pairs not related to the US Dollar could also see increased volatility and widening
spreads.
4. Trading the NFP data release can be dangerous due to the increase in volatility and possible
widening of spreads. To combat this, and to avoid getting stopped-out, we recommend using
the appropriate leverage, or no leverage at all.

Other important data releases to watch:

While the NFP generally moves the market, data like CPI (inflation), Fed funds rates, and GDP growth are
important data releases too.

If you want to know more about trading the news and data releases, see our trading the news beginner
guide. We also suggest reading our traits of successful traders guide to avoid the number one mistake
traders make when trading forex.

FURTHER READING ON FOREX FUNDAMENTALS

We also recommend finding out more about the role of central banks in the forex market, and
what central bank interventions involve.

Use the DailyFX economic calendar to keep an eye on all the important economic data releases, including
central bank speeches and interest rate data. Don’t forget to bookmark our Central Bank Rates Calendar so
you can prepare for regular announcements.

How Central Banks Impact the Forex Market

THE ROLE OF CENTRAL BANKS IN THE FOREX MARKET

Central banks are mainly responsible for maintaining inflation in the interest of sustainable economic growth
while contributing to the overall stability of the financial system. When central banks deem it necessary,
they will intervene in financial markets in line with the defined “Monetary Policy Framework”. The
implementation of such policy is highly monitored and anticipated by forex traders seeking to take
advantage of resulting currency movements.

This article focuses on the roles of the major central banks and how their policies affect the global forex
market.

WHAT IS A CENTRAL BANK?

Central Banks are independent institutions utilized by nations around the world to assist in managing their
commercial banking industry, set central bank interest rates and promote financial stability throughout the
country.

Central banks intervene in the financial market by making use of the following:

• Open market operations: Open market operations (OMO) describes the process whereby
governments buy and sell government securities (bonds) in the open market, with the aim of
expanding or contracting the amount of money in the banking system.

• The central bank rate: The central bank rate, often referred to as the discount, or federal funds
rate, is set by the monetary policy committee with the intention of increasing or decreasing
economic activity. This may seem counter-intuitive, but an overheating economy leads to inflation
and this is what central banks aim to maintain at a moderate level.
Central banks also act as a lender of last resort. If a government has a modest debt to GDP ratio and fails
to raise money through a bond auction, the central bank can lend money to the government to meet its
temporary liquidity shortage.

Having a central bank as the lender of last resort increases investor confidence. Investors are more at ease
that governments will meet their debt obligations and this helps to lower government borrowing costs.

MAJOR CENTRAL BANKS

Federal Reserve Bank (United States)

The Federal Reserve Bank or “The Fed” presides over the most widely traded currency in the world
according to the Triennial Central Bank Survey, 2016. Actions of The Fed have implications not only for
the US dollar but for other currencies as well, which is why actions of the bank are observed with great
interest. The Fed targets stable prices, maximum sustainable employment and moderate long-term interest
rates.

European Central Bank (European Union)

The European central bank (ECB) is like no other in that it serves as the central bank for all member states
in the European Union. The ECB prioritizes safeguarding the value of the Euro and maintaining price
stability. The Euro is the second most circulated currency in the world and therefore, generates close
attention by forex traders.

Bank of England
The Bank of England operates as the UK’s central bank and has two objectives: monetary stability and
financial stability. The UK operates using a Twin Peaks model when regulating the financial industry with
the one “peak” being the Financial Conduct Authority (FCA) and the other the Prudential Regulating
Authority (PRA). The Bank of England prudentially regulates financial services by requiring such firms to
hold sufficient capital and have adequate risk controls in place.

Bank of Japan

The Bank of Japan has prioritized price stability and stable operations of payment and settlement systems.
The Bank of Japan has held interest rates below zero (negative interest rates) in a drastic attempt to
revitalize the economy. Negative interest rates allow individuals to get paid to borrow money, but investors
are disincentivized to deposit funds as this will incur a charge.

CENTRAL BANK RESPONSIBILITIES

Central banks have been established to fulfil a mandate in order to serve the public interest. While
responsibilities may differ between countries, the main responsibilities include the following:

1) Achieve and maintain price stability: Central banks are tasked with protecting the value of their
currency. This is done by maintaining a modest level of inflation in the economy.

2) Promoting financial system stability: Central banks subject commercial banks to a series of stress
testing to reduce systemic risk in the financial sector.

3) Fostering balanced and sustainable growth in an economy: In general, there are two main avenues
in which a country can stimulate its economy. These are through Fiscal policy (government spending) or
monetary policy (central bank intervention). When governments have exhausted their budgets, central
banks are still able to initiate monetary policy in an attempt to stimulate the economy.

4) Supervising and regulating financial institutions: Central banks are tasked with the duty of
regulating and supervising commercial banks in the public interest.

5) Minimize unemployment: Apart from price stability and sustainable growth, central banks may have an
interest in minimizing unemployment. This is one of the goals from the Federal Reserve.

CENTRAL BANKS AND INTEREST RATES

Central banks set the central bank interest rate, and all other interest rates that individuals experience on
personal loans, home loans, credit cards etc, emanate from this base rate. The central bank interest rate is
the interest rate that is charged to commercial banks looking to borrow money from the central bank on an
overnight basis.

This effect of central bank interest rates is depicted below with the commercial banks charging a higher
rate to individuals than the rate they can secure with the central bank.
Commercial banks need to borrow funds from the central bank in order to comply with a modern form of
banking called Fractional Reserve Banking. Banks accept deposits and make loans meaning they need to
ensure that there is sufficient cash to service daily withdrawals, while lending the rest of depositors’ money
to businesses and other investors that require cash. The bank generates revenue through this process by
charging a higher interest rate on loans while paying lower rates to depositors.

Central banks will define the specific percentage of all depositors’ funds (reserve) that banks are required
to set aside, and should the bank fall short of this, it can borrow from the central bank at the overnight rate,
which is based on the annual central bank interest rate.

FX traders monitor central bank rates closely as they can have a significant impact on the forex market.
Institutions and investors tend to follow yields (interest rates) and therefore, changes in these rates will
result in traders channeling investment towards countries with higher interest rates.

HOW CENTRAL BANKS IMPACT THE FOREX MARKET?

Forex traders often assess the language used by the chairman of the central bank to look for clues on
whether the central bank is likely to increase or decrease interest rates. Language that is interpreted to
suggest an increase/decrease in rates is referred to as Hawkish/Dovish. These subtle clues are referred to
as “forward guidance” and have the potential to move the forex market.

Traders that believe the central bank is about to embark on an interest rate hiking cycle will place a long
trade in favor of that currency, while traders anticipating a dovish stance from the central bank will look to
short the currency.

Movements in central bank interest rates present traders with opportunities to trade based on the interest
rate differential between two country’s currencies via a carry trade. Carry traders look to receive overnight
interest for trading a high yielding currency against a low yielding currency.

LEARN MORE ABOUT FOREX FUNDAMENTALS

• DailyFX provides a dedicated central bank calendar showing all the scheduled central bank rate
announcements for major central banks.
• Keep up to date with crucial central bank announcements or data releases happening this week
via our economic calendar.
• Data releases have the ability to make significant moves in the FX market but with increased
volatility, it is important to manage your risk accordingly by learning how to trade the news.
NFP releases generally cause large movements in the forex market. The NFP data is normally released on
the first Friday of every month at 8:30 AM ET. This article will explain the role NFPs play in economics and
how to apply NFP release data to a forex trading strategy.

Interest Rates and the Forex markets

There’s a strong correlation between interest rates and forex trading. Forex is ruled by many variables, but
the interest rate of the currency is the fundamental factor that prevails above them all.

Simply put, money attempts to follow the currency with the highest real interest rate. The real interest rate
is the nominal interest rate less inflation.

Forex traders must keep an eye on each country’s central bank interest rate and more importantly, when it
is expected to change, to forecast moves in currencies.

This article will cover forex interest rates in depth, touching upon:

• What interest rates are and how they affect currencies.

• Forex interest rate differentials.
• How traders can forecast central bank rates and the impact on the FX market.
• Key forex interest rate trading strategies.

WHAT ARE INTEREST RATES AND WHY DO THEY MATTER TO FOREX TRADERS?

When traders talk about ‘interest rates’ they are usually referring to central bank interest rates. Interest
rates are of utmost importance to forex traders because when the expected rate of interest rates change,
the currency generally follows with it. The central bank has several monetary policy tools it can use to
influence the interest rate. The most common being:

• Open market operations: The purchase and sale of securities in the market with the goal of
influencing interest rates.
• The discount rate: The rate charged to commercial banks and other depository institutions on
loans they receive from their regional Federal Reserve Bank’s lending facility.

Central banks have two main tasks: to manage inflation and promote stability for their country’s exchange
rate. They do this by changing interest rates and managing the nation’s money supply. When inflation is
ticking upwards, above the central bank’s target, they will increase the central bank rate (using the policy
tools) which can restrict the economy and bring inflation back in check.

The economic cycle and interest rates

Economies are either expanding or contracting. When economies are expanding, everyone is better off,
and when economies are contracting (recession) they are worse off. The central bank aims to keep inflation
in check while allowing the economy to grow at a modest pace, all by managing the interest rate.

When economies are expanding (GDP Growth positive), consumers start to earn more. More earning leads
to more spending, which leads to more money chasing fewer goods – triggering inflation. If inflation is left
unchecked it can be disastrous, so the central bank attempts to keep inflation at its target level, which is
2% (for most central banks), by increasing interest rates. Increased interest rates make borrowing costlier
and helps reduce spending and inflation.

If the economy is contracting (GDP growth negative), deflation (negative inflation) becomes a problem. The
central bank lowers interest rates to spur spending and investment. Companies start to loan money at low
interest rates to invest in projects, which increases employment, growth, and ultimately inflation.

The cycle goes something like this:

HOW DO INTEREST RATES AFFECT CURRENCIES?

The way interest rates impact the forex markets is through a change in expectations of interest rates that
lead to a change in demand for the currency. The table below displays the possible scenarios that come
from a change in interest rate expectations:

MARKET EXPECTATIONS ACTUAL RESULTS RESULTING FX IMPACT

Rate Hike Rate Hold Depreciation of currency
Rate Cut Rate Hold Appreciation of currency
Rate Hold Rate Hike Appreciation of currency
Rate Hold Rate Cut Depreciation of currency
Interest rate relevance to forex trading

Imagine you are an investor in the UK that needs to invest a large sum of money in a risk-free asset, like a
government bond. Interest rates in the US are on the rise so you start to buy US Dollars to invest in the US
government bonds.

You (being the UK investor) are not alone in investing in the country with higher interest rates. Many other
investors follow the increase in yield and so increase the demand for US Dollars which appreciates the
currency. This is the essence of how interest rates affect currencies. Traders can attempt to forecast
changes in expectations of the interest rate which can have a large effect on the currency.

Here is an example of what happens when the market expects the central bank to keep interest rates on
hold, but then central bank decreases the interest rate. In this example, the Reserve Bank of Australia was
expected to keep interest rates on hold at 2% but instead cut it to 1.75%. The market was surprised by the
rate cut so the AUD/USD depreciated.

UNDERSTANDING FOREX INTEREST RATE DIFFERENTIALS

Interest rate differentials are simply differencing in interest rates between two countries.

If a trader expects the US to unexpectedly hike interest rates he/she anticipates the US dollar may
appreciate. To increase the trader’s chances of success, the trader can buy the US Dollar against a
currency with low interest rates as the two currencies are diverging in the direction of their respective
interest rates.

Interest rates and their differentials have a large influence on the appreciation/depreciation of the
currency pair. The changes in interest rate differentials are correlated to the appreciation/depreciation of
the currency pair. It is easier to understand visually. The chart below compares the AUD/USD currency
pair (candlestick graph) and the difference between the two-year AUD government bonds and the two-
year USD government bonds (orange graph). The relationship shows that as the AUD bonds yield
decreases relative to the USD bonds, so does the currency.
Interest rate differentials are widely used in carry trades. In a carry trade money is loaned from a country
with a low rate and invested in a country with a higher interest rate. There are, however, risks involved with
the carry trade such as the currency invested in depreciating relative to the currency used for funding the
trade.

HOW TO FORECAST CENTRAL BANK RATES AND THE IMPACT ON FX MARKETS

Fed funds futures are contracts traded on the Chicago Mercantile Exchange (CME) that represent the
markets expectations of where the daily official federal funds rate will be when the contract expires. The
market always has its own forecast of where the interest rate will be. A trader’s job is to forecast a change in
those expectations.

For a trader to forecast central bank rates he/she will need to keep a close eye on what the central bankers
are currently monitoring. Central bankers try to be as transparent as possible to the public about when
they expect to increase interest rates and which economic data they are currently monitoring.

The central bankers decide to increase or decrease interest rates based on several economic data points.
You can keep up to date with the release of these data points using an economic calendar. Inflation,
unemployment, and the exchange rate are some of the major data points. The trader must be in tune with
the central bank policy makers and almost try to forecast what their actions will be before they state it to
the public. This way the trader can reap the benefits of the markets change in expectations. This method
of trading is based on the fundamentals which is different to trading using technical analysis. See our article
on Technical vs Fundamental analysis to understand the different ways to analyze forex.

FOREX INTEREST RATE TRADING STRATEGIES

Forex traders can opt to trade the result of the interest rate news release, buying or selling the currency the
moment the news releases. See our guide on trading the news for more expert information.

Advanced forex traders may attempt to forecast changes in central banker’s tones, which can shift market
expectations. Traders will do this by monitoring key economic variables like inflation, and trade before
central banker’s speeches. See our Central Bank WeeklyWebinar for expert commentary on the latest and
upcoming central bank decisions.

Another method is to wait for a pullback on the currency pair after the interest rate result. If the central bank
unexpectedly hiked rates, the currency should appreciate, a trader could wait for the currency to depreciate
before executing a buy position- anticipating that the currency will continue to appreciate.
KEY CONCEPTS

1. The interest rate decisions themselves tend to be less important than the expectations for future
interest moves.
2. Trading currencies with increased interest rate differentials could increase the probability of
successful trades.
3. It is important to keep up to date with economic data using an economic calendar to forecast
potential changes in market expectations.

The Federal Reserve Bank: A Forex trader’s Guide

The Federal Reserve System (the Fed) was founded in 1913 by the United States Congress. The Fed’s
actions and policies have a major impact on currency value, affecting many trades involving the US Dollar.
Find out about the history of the Fed, its influence on USD and how to trade Fed monetary policy decisions.

WHAT IS THE FEDERAL RESERVE?

The Federal Reserve is the central bank of the United States. It was founded to create a stable, flexible
monetary and financial system for the nation. Its general duties are to set monetary policy and oversee
effective economic operation, ultimately serving the public interest.

To meet these top-level directives, the Fed performs five general functions:

1. Promote maximum employment, stable pricing and moderate interest rates long term
2. Reduce risk where possible to create a stable financial system
3. Develop safety within financial institutions
4. Champion safety within payment and settlement systems
5. Advocate consumer protection through a supervisory stance.
To execute day-to-day operations, the nation is divided up into 12 Federal Reserve Districts, each of which
is served by a separately incorporated Reserve Bank. These districts and member banks operate
independently while being supervised by the Federal Reserve Board of Governors.

Who owns the Fed?

The Fed is both a private and public institution. The Board of Governors is a government agency, while the
banks themselves are structured like private corporations – member banks hold stock and earn dividends.

Who is the Federal Reserve chairman?

As of August 2019, the chairman of the Federal Reserve is Jerome Powell, who has served in this office
since February 5, 2018. He is the 16th person to have held the position and will serve a four-year term.
Before his appointment, Mr Powell served as a member of the Board of Governors from May 25, 2012. He
also currently serves as Chairman of the Federal Open Market Committee, which looks after monetary
policy.

Which banks make up the Fed?

The 12 Federal Reserve Districts, each with their own Reserve Bank, are:

• Boston
• New York
• Philadelphia
• Cleveland
• Richmond
• Atlanta
• Chicago
• St. Louis
• Minneapolis
• Kansas
• Dallas
• San Francisco

How is the Fed held accountable to its functions?

The Fed is accountable to the public, as well as to the US Congress. The Chair and Federal Reserve
officials testify in front of Congress, while the system of setting monetary policy is designed to be clear and
transparent. In the interests of accountability, the Federal Open Market Committee (FOMC) will publish
statements following all annual meetings. All financial statements are audited independently once a year to
ensure financial accountability as well.

KEY ECONOMIC MANDATES OF THE FEDERAL RESERVE SYSTEM

US monetary policy is the core mandate of the Federal Reserve bank. The statutory objectives of this
monetary policy are outlined by the Congress and are:

• Maximum employment: The monetary policy set out by the FOMC should ensure
unemployment remains low, working to boost the economy where needed so that businesses
thrive, make a profit and hire more staff to grow
• Price stability: The Fed defines price stability as an inflation rate of 2% in the long term
 • Moderate long-term interest rates: This works alongside price stability – when an economy is
stable, long-term interest rates remain at a moderate level

The Fed aims to achieve its monetary policy through its influence over interest rates and the general
financial climate. This can lead to volatility of the US Dollar, ahead of Fed announcements and changes to
policies.

Federal Open Market Committee

Monetary policy is set by the Federal Open Market Committee (FOMC), which oversees the open market
operations of the Federal Reserve System. They set a target for the federal funds rate at FOMC meetings;
this is the interest rate that they want banks to offer to each other for overnight loans. While the FOMC
doesn’t control the rate, it can influence it in three main ways:

• Open market operations. This means the buying and selling of government bonds on the open
market – selling bonds decreases monetary supply with the aim of increasing interest rates. Buying
bonds puts money back into the economy, with the aim of decreasing interest rates
• Discount rate. This is the rate that banks pay to borrow money from the Fed. When this rate is
lower, then it is also more likely the federal funds rate will be lower too
• Reserve requirements. Banks need to hold a certain percentage of customers’ deposits to cover
withdrawals – this is the reserve requirement. When these are raised, banks can’t loan as much
money and must ask for higher interest rates. When lowered, banks can loan more money and ask
for lower interest rates.

HOW DOES THE FEDERAL FUNDS RATE AFFECT THE US DOLLAR?

The Fed’s interest rate, also known as the Fed funds rate, is set by the Board of Governors of the Federal
Reserve System. The current interest rate and the expectations of future interest rate changes can both
affect the value of the US Dollar. If traders anticipate a change in interest rates based on announcements
from the Board of Governors, this can cause the Dollar to appreciate or depreciate in value against other
currencies.

This table sets out the way in which market expectations and rate changes can affect the value of the
dollar:

MARKET EXPECTATIONS ACTUAL RESULTS RESULTING FX IMPACT

Rate Hike Rate Hold Depreciation of currency
Rate Cut Rate Hold Appreciation of currency
Rate Hold Rate Hike Appreciation of currency
Rate Hold Rate Cut Depreciation of currency

As you can see in the chart below, the Dollar strengthened against the Yen in the leadup to the Fed’s
interest rate announcement in December 2016 because it was widely expected that the fed funds rate
would increase. The pair peaked at around 118.371 on the day of the announcement, December 14, 2016.

USD/JPY chart before and after Fed hikes in 2016

HOW TO TRADE THE FED MONETARY POLICY DECISIONS

In order to prepare for Fed rate change decisions, traders should follow these two key steps:

1. Keep up with news from the Fed. The FOMC holds eight regular meetings a year, where policies
and interest rates are discussed and agreed upon. Keeping up with news ahead of these meetings
is the best way to make predictions about interest rates, and whether to buy or sell the US dollar
2. Keep with news from the markets. Rest assured that it won’t just be you speculating on interest
rates – ahead of Federal Reserve meetings and announcements, many forex traders will be
watching what happens very closely. Keep an eye out for others’ predictions and forecasts, and
stay well informed enough that you can have your own opinions and add your own logic to that of
others

No method of predicting interest rate decisions can ever be completely accurate and surprises do occur.
It’s always important to protect yourself when trading forex, so make sure you place stops in advance to
ensure you keep your losses to a minimum should the markets move against you.

Remember to stick to your trading plan and never place a trade where you wouldn’t be able to afford the
losses. Trades can go both ways. No matter how sure you feel that they will work in your favour, there’s
always the chance that they might not.

TOP TAKE AWAYS ON THE FED AND FOREX TRADING

• Traders should aim to keep track of developments within the Fed and look out for announcements
ahead of and after their FOMC meetings.
• See our Central Bank Calendar for important meeting dates and join our Central Bank Weekly
webinar.
• The US Dollar is one of the most widely traded currencies, but this doesn’t make it risk free – far
from it. Be aware of potential losses and know that are trade is never guaranteed to succeed. If
you’re just starting out in trading, download our New to FX guide to learn the basics.
• Keep up to date with monetary policy and general developments within the Fed. Currency value
and monetary policy are closely linked.

The European Central Bank: A Forex Trader Guide

The European Central Bank (ECB) is situated in Frankfurt, Germany. It was established in 1998 by the
Treaty of Amsterdam. The European Central Bank is different to other central banks in that it
controls monetary policy for the entire eurozone. Countries that belong to the eurozone include Austria,
Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg,
Malta, The Netherlands, Portugal, Slovakia, Slovenia and Spain.

WHAT IS THE ECB

The European Central Bank acts as the central bank for the 19 countries that belong to the eurozone. The
European Central Bank is overseen by a governing council that consists of six executive board members,
with one serving as the president. The executive board members are appointed by the European Council.

The European Central Bank’s primary objective is to maintain price stability. They use monetary policy to
support the economy and job creation.

KEY ECONOMIC MANDATES OF THE ECB

The European Central Bank’s primary mandate or objective is price stability. Price stability is the control of
inflation, Harmonized Index of Consumer Prices (HICP) and the exchange rate of the EUR.

1) Price Stability - which is price stability or inflation

2) Financial stability – Through the control of price stability and sometimes other mechanisms.

Price Stability

To maintain price stability, the European Central Bank influences the short-term interest rate for the
eurozone. The European Central Bank has a target interest rate (like most central banks) of below, or close
to, 2%. Although they target inflation mostly, GDP and unemployment data have a big effect on the
decisions the policy makers make.

If inflation goes above 2%, the European Central Bank may signal a hiking of the interest rate to the public
to tighten the eurozone’s economic expansion and bring down inflation. If unemployment numbers are
increasing and the economy is slowing down, the bank may have to make the decision to decrease interest
rates, to stimulate the economy and job growth. A period of rising inflation and increasing unemployment
will require the policy makers to weigh the pros and cons of tightening the economy to reign-in inflation or
stimulate the economy to produce jobs.
Financial Stability

The European Central Bank also plays a large role in keeping the eurozone’s financial system stable. In
times of a crisis, they can do this by adding liquidity to the system, either by buying bonds on the open
market or decreasing the interest rate to extremely low levels to help distressed debt holders pay back their
obligations.

If the European Central Bank does not add liquidity in times of a crisis, the entire financial system could
collapse.

HOW ECB INTEREST RATES AFFECT THE EURO

Interest rate impact on the Euro

The European Central Bank can affect the value of the Euro through changes in interest rate expectations.
Traders should understand that currencies tend to appreciate when interest rate expectations increase,
not just from increases in the nominal interest rate.

For example, if the European Central Bank keeps interest rates unchanged but issues forward guidance
(tells the market) that they expect more interest rate hikes in future, the value of the Euro tends to
appreciate.

A q uantitative easing program (QE) has a similar effect to interest rates on the Euro. Quantitative easing
is the buying of securities on the open market by a Central Bank in order to stimulate the economy and add
liquidity to the financial system. Historically it has only been done in times of a financial crisis. Increased
quantitative easing reduces the value of the Euro because it increases the amount of money in supply.

Interest rate impact on the economy

The European Central Bank lowers interest rates when it is trying to stimulate the economy (GDP) and
increases interest rates when it is trying to contain inflation caused by an economy operating above
potential (overheating).

Lower interest rates stimulate an economy in a few ways:

1. Businesses can borrow money and invest in projects that will receive more than the risk
borrowing rate.
2. When interest rates are lower the stock market is discounted at a lower rate, leading to an
appreciation in stock market values which causes a wealth effect.
3. People invest their money into the economy (stocks and other assets) because they can earn
more in these assets than at currently low interest rates.

How to trade ECB interest rate decisions

The table below displays the possible scenarios that come from a change in interest rate expectations.
Traders can use this information to forecast if the currency is likely to appreciate or depreciate and how to
trade it.

MARKET EXPECTATIONS ACTUAL RESULTS RESULTING FX IMPACT

Rate Hike Rate Hold Depreciation of currency
Rate Cut Rate Hold Appreciation of currency
MARKET EXPECTATIONS ACTUAL RESULTS RESULTING FX IMPACT
Rate Hold Rate Hike Appreciation of currency
Rate Hold Rate Cut Depreciation of currency

Let’s look at an example, EUR/USD, where the European Central Bank ended its long-time program of
quantitative easing. Ending the quantitative easing program means that the central bank would no longer
be adding more money to the system. On December 13, 2018 the European Central Bank announced an
end to its quantitative easing program, which led to an appreciation in the Euro because it signaled that
less money than expected would be in the economy.

TOP TAKEAWAYS OF THE ECB AND FOREX TRADING

• The European Central Bank is fundamental to the value of the Euro.

• The Euro tends to appreciate or depreciate depending on changes in interest rate expectations,
not just on actual changes.
• Quantitative easing has a similar effect to changes in interest rates. Changes in expectations of
quantitative easing will have an effect on the Euro.
• Rising inflation does not mean the European Central Bank will increase interest rates, it depends
on the balance between economic growth and inflation. The ECB will raise rates if inflation is close
to, at, or above target – the ECB’s primary mandate is to maintain price stability (inflation).

LEARN MORE ABOUT FOREX FUNDAMENTALS

Use the DailyFX economic calendar to keep an eye on all the important economic data releases, including
central bank speeches and interest rate data. Don’t forget to bookmark our Central Bank Rates Calendar
so you can prepare for regular announcements.

We also recommend finding out more about the role of central banks in the forex market, and central
bank interventions involve.
The Bank of England: A Forex trader Guide

THE BANK OF ENGLAND: A FOREX TRADER’S GUIDE

The Bank of England (BOE) is the UK’s central bank. Their mission is to promote and maintain monetary
and financial stability. It is important for forex traders to keep up to date with the Bank of England’s latest
changes to monetary policy because it can have a large effect on the Sterling Pound (GBP) and relevant
currency pairs, like the EUR which is highly correlated to the Pound.

WHAT IS THE BANK OF ENGLAND (BOE)?

Established in 1694, the Bank of England is the banker to, and owned by, the British government but is
independent when setting monetary policy. Its roles include the setting of monetary policy - which includes
targeting interest rates and using other tools to stimulate or contract the economy - producing the UK’s
bank notes, supervising some bank payment systems, and ensuring the stability and safety of the financial
system.

For traders, the BOE’s setting of monetary policy is a key factor to consider as it can have a big impact on
the financial markets. Other factors, like the independence of the central bank are also important but are
more prevalent issues in emerging market economies.

KEY ECONOMIC MANDATES OF THE BANK OF ENGLAND

According to the Bank of England, their two core purposes or mandates are:

1) Monetary stability - which is price stability or inflation

2) Financial stability - which is the stability and health of the economy

Monetary Stability

Monetary policy is extremely important for the entire economy. It prevents runaway inflation and attempts
to ground inflation expectations so that the economy can grow at a regular pace. In order to maintain price
stability, the Bank of England and their monetary policy committee (MPC) have set an inflation target of
2%.
If inflation goes above the target of 2% the Bank of England may increase interest rates. The increase in
interest rates may cause an appreciation in the Pound as investors increase capital flows into the higher
yielding currency. It may also have a negative affect on the stock market, as businesses will have to pay
higher rates to lend and equity valuations will be discounted at a higher interest rate. Monetary policy data
can be found on our economic calendar.

However, it is not always the case that the Bank of England will increase interest rates if inflation is above
target. In some cases, like when GDP growth is still low or negative, the Bank of England may keep interest
rates low to stimulate the economy. It is important to know the Bank of England will be looking for
a balance between healthy inflation and economic growth.

Financial Stability

The resilience of the financial system is paramount to the health of the UK economy and therefore
necessary for the Bank of England to accommodate. To support Financial Stability mandates, the bank also
has a Financial Policy Committee or FPC which was established in June 2011. From an FX point of view,
the Monetary Stability is the key driver of spot rates for the GBP.

HOW BOE INTEREST RATES AFFECT THE POUND

Interest rate impact on the Pound

The Bank of England can affect the value of the Pound through changes in interest rate expectations.
Traders should understand that currencies appreciate when interest rate expectations increase, not just
from increases in the nominal interest rate.

For example, if the Bank of England keeps interest rates unchanged but issues forward guidance (tells the
market) that they expect more interest rate hikes in future, the value of the Pound will appreciate. Likewise,
decreases in future interest rate hike expectations, or expectations of an interest rate cut can lead to a
decrease in the value of the Pound.

This is the general principle for how interest rates affect the Pound and stock market, although they
sometimes react differently:

1. Higher interest rate expectations increase the strength of the Pound (GBP)
and negatively affect equity values.
2. Lower interest rate expectations decrease the strength of the Pound (GBP) and positively affect
equity values.

Interest rates aren’t the only monetary policy tool that can affect the currency, tools like quantitative easing
can also lead to increases and decreases in the value of a currency. If the Bank of England announces that
it plans to start a quantitative easing program (QE), the pound will likely depreciate as a large amount
of liquidity enters the market, increasing the supply of money in the market and leading to a decrease in
interest rates, or, simply to maintain current rates.

Interest rate impact on the economy

The Bank of England lowers interest rates when it is trying to stimulate the economy (GDP) and increases
interest rates when it is trying to contain inflation caused by an economy operating above potential
(overheating).

Lower interest rates stimulate an economy in a few ways:

 1. Businesses can borrow money and invest in projects that will receive more than the risk
borrowing rate.
2. When interest rates are lower the stock market is discounted at a lower rate, leading to an
appreciation in stock market values which causes a wealth effect.
3. People invest their money into the economy (stocks and other assets) because they can earn
more in these assets than at currently low interest rates.

How to trade BOE interest rate decisions

The table below displays the possible scenarios that come from a change in interest rate expectations.
Traders can use this information to forecast if the currency is likely to appreciate or depreciate and how to
trade it.

MARKET EXPECTATIONS ACTUAL RESULTS RESULTING FX IMPACT

Rate Hike Rate Hold Depreciation of currency
Rate Cut Rate Hold Appreciation of currency
Rate Hold Rate Hike Appreciation of currency
Rate Hold Rate Cut Depreciation of currency

Let’s look at the example below on GBP/USD. On August 4, 2016 the Bank of England cut interest rates
and announced a stimulus package (quantitative easing program). The market reacted negatively and the
Pound depreciated.

TOP TAKEAWAYS OF THE BOE AND FOREX TRADING

• The Bank of England is fundamental to the value of the Pound

• The Pound will appreciate or depreciate depending on changes in interest rate expectations,
not just on actual changes.
• Quantitative easing has a similar effect to changes in interest rates. Changes in expectations of
quantitative easing will have an effect on the Pound.
• Rising inflation does not mean the Bank of England will increase interest rates, it depends on the
balance between economic growth and inflation.

LEARN MORE ABOUT FOREX FUNDAMENTALS

Use the DailyFX economic calendar to keep an eye on all the important economic data releases, including
central bank speeches and interest rate data. Don’t forget to bookmark our Central Bank Rates Calendar
so you can prepare for regular announcements.

We also recommend finding out more about the role of central banks in the forex market, and central
bank interventions involve.

If you are just getting started on your trading journey, get to grips with the basics of forex trading in
our New to Forex trading guide.

The Swiss National Bank: A Forex trader’s Guide

The Swiss National Bank (SNB) is Switzerland’s Central bank. Their mission is to promote and maintain
monetary and financial stability. It is important for traders to keep up to date with the SNB’s latest changes
to monetary policy because it can have a large effect on the Swiss Franc (CHF).

WHAT IS THE SNB?

The Swiss National Bank was established in 1907. It is responsible for the monetary policy of Switzerland
and issues Swiss Franc banknotes. As of 2015, the Swiss National Bank is privately owned with most
shares belonging to the Swiss Cantons. Like other central banks, the SNB uses different monetary policy
tools to bring about price stability and take account of economic developments.

The factor that holds the most importance to traders is monetary policy, which we will explain in depth in
this article. Other factors, like the independence of the central bank are also important but are more
prevalent issues in emerging market economies.

KEY ECONOMIC MANDATES OF THE SWISS NATIONAL BANK

According to the Swiss National Bank, their primary goals are:

1. Price stability - which is stability of the exchange rate and/or inflation

2. Economic development - which is focus of development and stability of the economy

Price Stability
Monetary policy is extremely important for the entire economy. It prevents runaway inflation and attempts
to ground inflation expectations so that the economy can grow at a regular pace. In order to maintain price
stability, the Swiss National Bank and their monetary policy committee (MPC) have set an inflation target
of less than 2% for CPI per annum.

If inflation goes above the target of 2%, the Swiss National Bank may have to increase interest rates. The
increase in interest rates may cause an appreciation in the Swiss Franc (CHF) as investors increase capital
flows into the higher yielding currency. It may also have a negative effect on the stock market, as businesses
will have to pay higher rates to lend and equity valuations will be discounted at a higher interest rate.
Monetary policy data can be found on our economic calendar.

However, it is not always the case that the Swiss National Bank will increase interest rates if inflation is
above target. In some cases, like when GDP growth is still low or negative, the Swiss National Bank may
keep interest rates low to stimulate the economy. It is important to understand that the Swiss National Bank
will be looking for a balance between healthy inflation and economic growth.

Economic Development

Economic developments are intertwined with monetary policy. Changes in economic outlook often cause
central bankers to update their monetary policy plans in order to stabilize the economy.

HOW SNB INTEREST RATES AFFECT THE SWISS FRANC (CHF)

The Swiss National Bank can affect the value of the Swiss Franc through changes in interest rate
expectations. Traders should understand that currencies appreciate/depreciate when interest
rate expectations increase/decrease, not just from increases in the nominal interest rate.

The Swiss Central Bank, like most central banks, use different monetary policy tools to control the interest
rate. The forex market normally prices in current interest rate expectations, changes in these expectations
can cause the Swiss Franc to depreciate or appreciate. The Swiss National Bank can do this by giving the
market forward guidance (telling the market) that they expect further hikes or less hikes (or cuts) in the
future.

The general principle for how interest rates affects the Swiss Franc and the stock market are given below:

1. Higher interest rate expectations increase the strength of the Swiss Franc and negatively affect
equity values.
2. Lower interest rate expectations decrease the strength of the Swiss Franc and positively affect
equity values.

Interest rate impact on the economy

The Swiss National Bank lowers interest rates when it is trying to stimulate the economy (GDP) and
increases interest rates when it is trying to contain inflation caused by an economy operating above
potential (overheating).

Lower interest rates stimulate an economy in a few ways:

1. Businesses can borrow money and invest in projects that will receive more than the risk
borrowing rate.
2. When interest rates are lower the stock market is discounted at a lower rate, leading to an
appreciation in stock market values which causes a wealth effect.
 3. People invest their money into the economy (stocks and other assets) because they can earn
more in these assets than at currently low interest rates.

How to trade SNB interest rate decisions

The table below displays the possible scenarios that come from a change in interest rate expectations,
traders can use this information to forecast if the currency is likely to appreciate or depreciate and how to
trade it.

MARKET EXPECTATIONS ACTUAL RESULTS RESULTING FX IMPACT

Rate Hike Rate Hold Depreciation of currency
Rate Cut Rate Hold Appreciation of currency
Rate Hold Rate Hike Appreciation of currency
Rate Hold Rate Cut Depreciation of currency

Let’s look at the example below on the EUR/CHF. In 2015 the Swiss National Bank took the market by
surprise by abandoning an exchange rate cap on the Swiss Franc. The Swiss Franc, which was capped to
the EUR at 1.2 francs per Euro appreciated around 20% initially, policy makers then began to cut interest
rates leading to a depreciation of the Swiss Franc.

TOP TAKEAWAYS OF THE SNB AND FOREX TRADING

• The Swiss National Bank is fundamental to the value of the Swiss Franc.
• The Swiss Franc will appreciate or depreciate depending on changes in interest
rate expectations, not on actual changes.
• Quantitative easing has a similar effect to changes in interest rates. Changes in expectations of
quantitative easing will have an effect on the Swiss Franc.
• Rising inflation does not mean the Swiss National Bank will increase interest rates, it depends on
the balance between economic growth and inflation.

LEARN MORE ABOUT FOREX FUNDAMENTALS

Use the DailyFX economic calendar to keep an eye on all the important economic data releases,
including central bank speeches and interest rate data. Don’t forget to bookmark our Central Bank Rates
Calendar so you can prepare for regular announcements.
We also recommend finding out more about the role of central banks in the forex market, and
what central bank interventions involve.

The Bank Of Japan: A Forex Trader’s Guide

The Bank of Japan (BoJ) is a major central bank, setting the monetary policies that aim to maintain price
stability and a strong Japanese financial system. As a central bank, the BoJ directly impacts the forex
market, so policy meetings and the decisions they bring about are important for FX traders to follow.

WHAT IS THE BANK OF JAPAN?

The Bank of Japan, or Nichigin, is the Japanese central bank. It implements monetary policy and issues
currency to maintain stability of the financial system. The bank’s Policy Board holds regular monetary policy
meetings, deciding on their approach to interest rates, and how they intend to influence inflation.

WHO OWNS THE BANK OF JAPAN?

The government of Japan has a 55% ownership of the bank, and 100% voting interest. The remaining 45%
is a public float, traded as JASDAQ. As of August 2019, the BoJ governor is Haruhiko Kuroda, who has
held the position since March 2013 and is currently serving his second five-year term, which is due to run
until April 2023.

KEY ECONOMIC MANDATES OF JAPAN’S CENTRAL BANK

The BoJ considers its core mandates to be:

1. Maintaining stability of the financial system

2. Maintaining price stability

Maintaining stability of the financial system

The BoJ implements its monetary policy with the aim of maintaining financial system stability, which involves
currency control, monetary control and the issuing of banknotes. This also feeds into the BoJ’s other core
aim, as currency and monetary control is part of the plan to achieve price stability and develop the economy.

Maintaining price stability

Maintaining price stability is the other central aim of the BoJ. Exports are essential to Japan, so the BoJ
tries to keep prices as stable as possible and will manipulate interest rates with the intention of developing
the national economy. The bank defines ‘price stability’ as a 2% increase year on year in the Consumer
Price Index (CPI).

How does the BoJ carry out its mandates?

The BoJ holds regular monetary policy meetings (MPMs), where it sets the official interest rate and other
monetary policies in the hope that they will achieve price stability and financial system stability. MPMs are
held eight times a year and last for two days, during which time the Policy Board (the Governor, two Deputy
Governors and six other members) will discuss and implement monetary policy. As of July 2018, the base
rate remains set at -0.1% in the hope of growing the economy.
HOW BANK OF JAPAN MONETARY POLICIES AFFECT THE YEN

Japan has suffered from an ailing economy with very low inflation over the course of the last few
decades, consistently failing to achieve 2% inflation. The BoJ has adopted what is known as a loose
monetary policy, maintaining a low interest rate in the hope of boosting the economy.

When there is little incentive to save due to a low interest rate, the idea is that people will spend more, put
money into the economy and encourage inflation. This has seen the yen becoming increasingly weak
against major currencies, including the US Dollar and the Euro, ever since Kuroda took office.

USD/JPY went from 94.00 in March 2013 to over 125.00 in June 2015, after Kuroda announced his first
raft of policy measures. And while it has fluctuated since then, the yen’s value has remained well below
its level when he became governor, with USD/JPY sitting around 108.00 in July 2019.

USD/JPY chart showing the fluctuations in value around major BoJ announcements

Following a period from 2012 to 2013 when the yen was relatively strong against the US Dollar, it fell to
USD/JPY 125.00 in June 2015 after the announcement of Kuroda’s initial policy measures. The value fell
once again in January 2016, when Kuroda made the shock announcement that the bank would implement
a negative interest rate for the first time ever, charging -0.1% on deposits held with the bank. This policy
aims to get financial institutions to withdraw their cash to invest elsewhere, rather than making a loss by
hoarding cash.

This announcement caught the markets by surprise as Kuroda had only recently told the parliamentary
budget committee that he was not looking to introduce any policy changes for the time being. The yen fell
against currencies including the dollar and pound, while the Japan 225 went up in the hours following his
announcement.

HOW TO TRADE BOJ INTEREST RATE DECISIONS

BoJ interest rate decisions are made with the aim of increasing spending and investment, influencing
inflation. Changes in demand for stocks and currency as interest rates change can create forex trading
opportunities. Even when interest rates remain the same, the anticipation surrounding important events like
monetary policy meetings can affect the forex market.
Short-term interest rates are fundamental in determining currency valuation, so traders will watch them
closely. Here’s the general pattern:

MARKET EXPECTATIONS ACTUAL RESULTS RESULTING FX IMPACT

Rate Hike Rate Hold Depreciation of currency
Rate Cut Rate Hold Appreciation of currency
Rate Hold Rate Hike Appreciation of currency
Rate Hold Rate Cut Depreciation of currency

Trading interest rate decisions can be enhanced by:

• Following our news and analysis, and trading forecasts to keep up to date with markets
• Joining our Central Bank Weekly webinar for the most relevant information from the world’s major
central banks
• Sticking to a trading plan – if the yen is volatile, traders need to make sure they can afford to
incurlosses, as its value could go in either direction.

TOP TAKEAWAYS OF THE BOJ AND FOREX TRADING

• The Bank of Japan has a fundamental role in determining the value of the yen
• Short-term changes to interest rates are a key factor in currency valuation
• Bank of Japan monetary policy meetings can influence the value of the yen, as this is when key
decisions are made.

Central Bank Intervention in the Foreign Exchange Market

FOREIGN EXCHANGE INTERVENTIONS BY CENTRAL BANKS: MAIN TALKING POINTS

Central banks often deem it necessary to intervene in the foreign exchange market to protect the value of
their national currency. Central banks can achieve this by buying or selling foreign exchange reserves or
simply by mentioning that a particular currency is under or over-valued, allowing participants of the forex
market to do the rest. This article looks at the different types of central bank interventions and important
facts to keep in mind before trading.

WHAT IS FOREIGN EXCHANGE INTERVENTION?

Foreign exchange intervention is the process whereby a central bank buys or sells foreign currency in an
attempt to stabilize the exchange rate, or to correct misalignments in the forex market. This is often
accompanied by a subsequent adjustment, by the central bank, to the money supply to offset any
undesirable knock-on effects in the local economy.

The mechanism mentioned above, is referred to as “sterilized intervention” and will be discussed later on,
along with the other currency intervention methods.

HOW FOREX TRADERS CAN TRADE A CENTRAL BANK INTERVENTION

Traders must keep in mind that when central banks intervene in the forex market, moves can be extremely
volatile. Therefore, it is essential to set an appropriate risk to reward ratio and make use of prudent risk
management.
Central banks intervene in the forex market when the current trend is in the opposite direction to where the
central bank desires the exchange rate to be. Therefore, trading around central bank intervention is a lot
like trading reversals.

Additionally, the forex market tends to anticipate central bank intervention meaning that it is not uncommon
to see movements against the long-term trend in the moments leading up to central bank intervention. Since
there is no guarantee that traders can look for the new trend to emerge before placing a trade.

WHY DO CENTRAL BANKS INTERVENE IN THE FOREIGN EXCHANGE MARKET?

Central banks generally agree that intervention is necessary to stimulate the economy or maintain a desired
foreign exchange rate. Central banks will often buy foreign currency and sell local currency if the local
currency appreciates to a level that renders domestic exports more expensive to foreign nations. Therefore,
central banks purposely alter the exchange rate to benefit the local economy.

Below is an example of successful central bank intervention in response to Japanese Yen strength against
the US dollar. The Bank of Japan was of the view that the exchange rate was unfavorable and swiftly
intervened to depreciate the Yen thus, resulting in a move higher for the USD/JPY pair. The intervention
took place in the timespan depicted by the blue circle and the effect was realised shortly thereafter.

While most central bank intervention is successful, there are instances when this in not the case. The chart
below depicts a currency intervention example in the USD/BRL (Brazilian Real) currency pair. The chart
highlights both instances where the central bank intervened to stop the decline in the Brazilian Real. It is
clear to see that both scenarios failed to immediately strengthen the Real against the US dollar as the dollar
continued to rise higher and higher.
HOW DOES CURRENCY INTERVENTION WORK?

Central banks have a choice of different types of interventions to make use of. These can either be direct
or indirect. Direct intervention, as the name suggests, has an immediate effect on the forex market, while
indirect intervention achieves the objectives of the central bank via less invasive means. Below are
examples of direct and indirect intervention:

TYPES OF INTERVENTION DIRECT OR INDIRECT

Jawboning Indirect
Operational Intervention Direct
Concerted Intervention Direct and indirect
Sterilized Intervention Direct

• Operational Intervention: This is usually what people mean when they refer to central bank
intervention. It involves the central bank buying and selling both foreign and local currency to drive
the exchange rate to a targeted level. It is the pure size of these transactions that move the market.

• Jawboning: this is an example of indirect FX intervention whereby a central bank mentions that it
may intervene in the market if the local currency reaches a certain undesirable level. This method,
as the name suggests, is more about talking than actual intervention. With the central bank ready
to intervene, traders take it upon themselves to collectively bring the currency back to more
acceptable levels.

• Concerted Intervention: This is a combination of jawboning and operational intervention and is

most effective when multiple central banks voice the same concerns over exchange rates. If a
number of central banks increase their jawboning efforts, it is likely that one of them actually
conducts operational intervention to drive the exchange rate in the desired direction.

• Sterilized intervention: Sterilized intervention involves two actions from the central bank in order
to influence the exchange rate and at the same time, leave the monetary base unchanged. This
involves two steps: The sale or purchase of foreign currency, and an open market operation (selling
or buying government securities) of the same size as the first transaction.
Hawkish vs Dovish: How monetary policy affects FX Trading

You have probably heard a financial news presenter say something along the lines of “The central bank
governor came out slightly hawkish today after bouts of strong economic data”. The terms Hawkish and
Dovish refer to whether central banks are more likely to tighten (hawkish) or accommodate (dovish)
their monetary policy.

Central bank policy makers determine whether to increase or decrease interest rates, which have significant
impact on the forex market. Policy makers increase interest rates to prevent an economy from overheating
(to prevent inflation from going too high) and they decrease interest rates to stimulate an economy (to
prevent deflation and stimulate GDP growth).

Hawkish and dovish policies affect currency rates through a mechanism central banker like to call “forward
guidance”. This is policy makers trying to be as transparent as possible in their communications to the
market about where monetary policy may be heading.

Keep reading to learn more about hawkish and dovish policies and how to apply this knowledge to your
forex trades.

WHAT DOES HAWKISH MEAN?

The term hawkish is used to describe contractionary monetary policy. Central bankers can be said to be
hawkish if they talk about tightening monetary policy by increasing interest rates or reducing the central
bank’s balance sheet. A monetary policy stance is said to be hawkish if it forecasts future interest rate
increases. Central bankers can also be said to be hawkish when they are positive about the economic
growth outlook and expect inflation to increase.

Currencies tend to move the most when central bankers shift tones from dovish to hawkish or vice versa.
For example, if a central banker was recently dovish, stating that the economy still requires stimulus and
then, in a later speech, stated that they have seen inflation pressures rising and strong economic growth,
you could see the currency appreciate against other currencies.

Some words that could be used describing a hawkish monetary policy include:

• Strong economic growth

• Inflation increasing
• Reducing the balance sheet
• Tightening of monetary policy
• Interest rate hikes

Generally, words used that indicate increasing inflation, higher interest rates and strong economic growth
lean towards a more hawkish monetary policy outcome.

WHAT DOES DOVISH MEAN?

Dovish refers to the opposite. When central bankers are talking about reducing interest rates or increasing
quantitative easing to stimulate the economy, they are said to be dovish. If central bankers are pessimistic
about economic growth and expect inflation to decrease or become deflation and they signal this to the
market through their projections or forward guidance, they are said to be dovish about the economy.

Some words that could be used to describe a dovish monetary policy, include:
 • Weak economic growth
• Inflation decreasing/deflation (negative inflation)
• Increasing the balance sheet
• Loosening of monetary policy
• Interest rate cuts

HAWKISH VS DOVISH EXPLAINED

The below graphic provides a snapshot of the main differences between hawkish and dovish monetary
policy:

The table below provides a more in depth comparison on dovish vs hawkish monetary policies,
highlighting the differences between the two and how they impact currencies.

HAWKISH MONETARY POLICIES DOVISH MONETARY POLICIES

Increasing interest rates to stem inflation Decreasing interest rates to stimulate the economy
pressures → Currency could depreciate as capital flows to a lower
→ Currency could appreciate as capital flows interest rate currency
to higher interest rate currency

Reducing the Federal Reserve balance sheet Increasing the Federal Reserve balance sheet through
by selling mortgaged backed securities quantitative easing (QE). QE is the purchasing of MBS and
(MBS) and treasuries treasuries that increase the money supply in the economy to
→ Currency could appreciate as selling of stimulate it.
treasuries and MBS could increase interest → Currency could depreciate as an increase in money supply
rates decreases demand for the currency

Forward guidance from central banks Forward guidance from central banks includes negative
includes positive statements about the statements about the economy, economic growth, and signs of
economy, economic growth, and inflation deflation.
outlook. → Currency could depreciate as investors forecast interest rate
→ Currency could appreciate as investors cuts
forecast further interest rate hikes
HOW TO TRADE A HAWKISH OR DOVISH CENTRAL BANK

A slight shift in tone from a central banker could have drastic consequences for a currency. Traders often
monitor Federal Open Market Committee meetings and minutes to look for slight changes in language that
could suggest further rate hikes or cuts and attempt to take advantage of this.

Monetary policy standing as at 1 January 2019

The image above shows the different central banks current monetary policy stance. When a central banks’
monetary policy stance moves more towards the left (dovish) their currency could depreciate against other
currencies. If the monetary policy stance moves more towards the right (hawkish) their currency could
appreciate.

Trading a hawkish or dovish central bank isn’t as easy as buying a hawkish central bank currency or selling
a dovish central bank currency. It has to do with changing interest rate expectations. Let’s look at two
scenarios:

Scenario 1:

If a central bank is currently in a rate hiking cycle, the market will have already forecasted future interest
rate hikes. It is the job of the trader to watch for clues and economic data that could shift the tone of the
central bank to either more hawkish than currently, or to dovish. Currencies could move a large amount
when the monetary tones shift from what they are currently.

Scenario 2:

Likewise, if a central bank is currently cutting rates and economic data hasbeen negative, the market would
have priced-in the current dovish monetary stance. Traders would have to watch the central bankers
forward guidance and economic data, which you can find on an economic calendar, for clues to whether
they may become more dovish than currently, or hawkish.

In late 2018 the federal reserve was quite hawkish. Federal Reserve Chairman, Jerome Powell, stated that
“we’re a long way away from neutral at this point” which the market perceived as hawkish (2 Oct 2018).
This implied that the Federal Reserve still had to hike rates many more times to get to the neutral rate.
Then on the 28th of November, the FOMC released their statement of monetary policy in which Jerome
Powell said he saw rates at “just below neutral”. This shift in tone is like scenario 1 above, where the central
banks shifts tone from hawkish to slightly dovish. Leading to a depreciation of the currency- see the charts
below that show what happened to the Dollar Index (DXY) on the October 2, 2018 and then on the
November 28, 2018.

October 2, 2018 - Federal Reserve Chairman, Jerome Powell says “We’re a long way away from
neutral at this point” leading to appreciation of the Dollar.

15min US Dollar index chart, vertical line indicating October 2, 2018.

November 28, 2018 Federal Reserve Chairman says that interest rates are “just below neutral”
indicating a shift in tone from hawkish to dovish. Dollar depreciations.

15min USD Dollar index chart

Keeping up to date with central banks can be difficult. At DailyFX we have a Central Bank Weekly
Webinar where we analyze central bank decisions and keep you up to date with central bank activity.

If you are just starting out on your trading journey it is essential to understand the basics of forex trading in
our New to Forex guide. We also offer a range of trading guides to supplement your forex knowledge and
strategy development.
Senior Analyst, Tyler Yell of DailyFX sat down with former Federal Reserve Advisor, Danielle DiMartino
Booth in a podcast that covered global central bank developments and Danielle’s biggest lesson she
learned as a Fed insider.

Understanding Inflation for Currency trading

Inflation is one of the most important gauges for a currency trader to track, yet one of the more confusing
pieces of data. A high inflation rate might normally be a bullish sign for one currency, but at the same time
it could also be currency negative. Therefore, we layout a guide to understanding inflation and how it affects
foreign exchange trading.

Inflation reports monitor the rise of the prices of basic goods and services in an economy, inversely the rate
at which purchase power is falling. Think of it as a measure of how much you can buy with a dollar; e.g. if
you can buy a quart of milk for $2, after a 2% inflation, that same quart will cost $2.04. The main cause for
a higher inflation rate is a growth of money supply without an equal growth in the country’s assets; and
most economists agree that a low and steady inflation rate is good for an economy, approximately 2-3% a
year.

Inflation is measured by the Consumer Price Index (CPI) and Producer Price Index (PPI) reports. CPI
measures the cost of a sample of goods and services on a consumer level, it’s considered the final stage
of inflation; the higher the CPI, the higher the level of inflation. Core CPI excludes goods that are more
volatile and whose price changes are less indicative of inflation, while seasonally affected CPI factors in
the usual seasonal changes. The PPI measures what firms are charging each other for goods and services;
it’s a look at upstream inflation.

An alternative to the CPI is the Personal Consumption Expenditure (PCE), which switches the specific
goods and services that make up its sampling more often than the CPI. Therefore, the PCE is the preferred
consumer inflation gauge for the Federal Reserve.

Additionally, the Institute for Supply Management (ISM) reports an index that measures the price paid by
and received by firms. Oil prices should also be considered for clues to inflation, as higher oil prices may
lead to higher inflation.

So, how does inflation impact the currency markets? Besides for a growth in money supply, inflation is also
driven higher by low interest rates, because the excess money pushed by low interest into the economy
drives prices up. Therefore, high inflation usually leads to the central bank raising interest rates, while lower
than desired inflation rates can lead to lowering of interest rates. A higher interest might attract investors
looking for a big return on their currency holdings, while a low interest rate currency might be sold for a
better paying alternative.

However, the above process is only true when growth is generally good in the country’s economy; if growth
is bad, high inflation can have an adverse effect on a currency. Poor growth coupled with high inflation can
point to a recession, which could lead to interest rate cuts in the long run. Therefore, only trade on the
assumption that high inflation will lead to high interest rates when the economic environment is stable or
healthy. Otherwise, consider that the high inflation may hurt a currency in slow growth scenarios. That is
why we refrain from automatically labeling an inflation reading as ‘better than expected’, or ‘worse than
expected’.

Additionally, the interest rate you usually see is the nominal interest rate, which doesn’t factor in inflation.
Markets focus more on real interest rates, which subtracts the inflation rate from the interest rate. So, high
inflation can lower a nominally large interest rate when looking at the real rate, while deflation can add to a
real interest rate.
Furthermore, always be aware of the central banks’ current sentiments about interest rate policy, and look
out for news about members’ new sentiments following inflation changes. When reading news about a
central bank outlook, remember that a hawkish sentiment means the bank member(s) want to fight inflation
by raising interest rates, while a dove wants to keep interest rates low.

In summary, in a healthy economy, rising inflation likely points to higher interest rates, this in turn will favor
the currency under discussion. However, in tougher economic times or in a slow growth period, consider
all the factors mentioned above before placing trades based on inflation rate reports or expectations.

Inflation and CPI

The CPI is the most widely used measure of inflation and is sometimes viewed as an indicator of the
effectiveness of government economic policy. It provides information about price changes in the nation's
economy charged to government, business, labor, and private citizens. It is customarily used by them as
a guide to making economic decisions. In addition, the President, Congress, and the Federal Reserve
Board use trends in the CPI to aid in formulating fiscal and monetary policies.

The Consumer Price Index is the average change over time in the prices paid by urban consumers for a
“market basket” of consumer goods and services. The CPI basket is developed from detailed expenditure
information provided by families and individuals on what they actually bought. Most of the specific CPI
indexes in the USA have a 1982-84 reference base. That is, the Bureau of Labor Statistics (BLS) sets the
average index level (representing the average price level) for the 36-month period covering the years 1982,
1983, and 1984-equal to 100. The BLS then measures changes in relation to that figure. An index of 110,
for example, means there has been a 10% increase in price since the reference period; similarly, an index
of 90 means a 10% decrease. For the current CPI, this information was collected from the Consumer
Expenditure Surveys for 2005 and 2006. It is not an exact record of individual households’ spending, but
it gives a good idea of how price increases affect typical household spending, and the change in one dollar’s
‘buying power’ because of inflation.

The CPI is comprised of all goods and services purchased for consumption by the reference
population. Major groups and examples of categories in each are as follows:

• FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full-service meals, snacks)

• HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)

• APPAREL (men's shirts and sweaters, women's dresses, jewelry)

• TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)

• MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye
care, hospital services)

• RECREATION (televisions, toys, pets and pet products, sports equipment, admissions)

• EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer

software and accessories)

• OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal
services, funeral expenses).

The change shown month-to-month or year-to-year by comparing index numbers is usually expressed as
a percentage – for example, ‘consumer prices have increased by 0.3 percent since last month'.
This percentage change is often referred to as the inflation rate – eg, ‘the inflation rate for the last 12
months is 2.5 percent'.

This graphic shows the effect of the inflation rate on the price of a basket of goods. If the year’s inflation
rate was 2.5 percent, the same selection of goods that cost $400 12 months earlier, can now be purchased
at a cost of $410.

Many investors and the Fed constantly monitor this figure to get an understanding about the future of
interest rates. Interest rates are significant because, in addition to having a direct impact on the amount of
capital inflow into the country, they also say much about dollar-based carry trades. If the inflation number
comes in higher than expected, traders will interpret that to mean that an interest rate hike is more likely in
the near future and will thus buy the currency, whereas a figure that falls short of expectations may cause
traders to wait on the sideline until the Central Bank actually makes a decision. Essentially, trading a
negative change in CPI is much more difficult than trading a positive change due to the nature of different
interpretations. A significant increase in the CPI will result in much bullishness, but a decrease will not
necessarily result in bearishness. The CPI measures inflation at the retail level (consumers), while the PPI
(Producer’s Price Index) measures the inflation at the wholesale level (producers).

In the United States, the CPI numbers come out once a month. When the numbers come out (around the
middle of each month), they reflect the data for the prior month. CPI is also released monthly in Europe,
the UK, Canada, and Japan. Many other countries release this data only quarterly. The dates of these
announcements and many other pieces of fundamental trading data can be followed at the Daily FX Global
Economic Calendar which can be accessed at

Geo-Political events:

Geo-Political events can have a notable effect on the FX market.

The other fundamental announcements that we have discussed previously could all fall under the heading
of “scheduled events”. Each of them has a date on the calendar as to when they will be announced, making
them fairly easy to follow and to plan our trading around. In this category, however, “unscheduled and
unpredicted” would be the order of the day.

The key component to remember here is that money abhors uncertainty. It flees first and asks questions
later.

Events of a political nature, such as wars, local conflicts, elections or terrorist activity -- along with weather-
related disasters such a hurricane, tsunamis, etc can impact how currency pairs trade quite dramatically.
In the case of Presidential elections in the US, if it appears that there may be a change of political party the
run up to the election can be a pretty “flat” time for markets as traders do not want to commit too strongly
in either direction or for the longer term. If a new party comes into office, the first several months, until the
new President demonstrates their attitude relative to the financial markets can be a time a testing as
well. Nothing too dramatic takes place until investors and traders feel they have a “take” on what the longer-
term economic posture will be.

In the case of weather-related events, an example would be if a hurricane went up through the Gulf of
Mexico and took out numerous oil platforms. Clearly this would diminish the supply of oil, and since
the Canadian Dollar is so correlated with its price, the CAD would quite likely experience some movement.

On the above chart, the correlation between the price of oil and the Canadian Dollar can be seen. As oil
goes up, the value of the CAD goes up as well. This chart appears to show an inverse relationship, but
that is due to the CAD being the cross currency in the USD/CAD pair.

One of the keys things a trader can take away from this is that protective stops always need to be in place
on all trades. Given the unpredictable nature of world events along with the complete lack of a “timetable”,
as is the case with the other fundamental events, a trader can never be too safe.

So now you know a bit more about the part that geopolitical events play in the currency market.

Non-Farm Payrolls

Non-Farm Payrolls and Trading News Events

Every trader knows (or should know) the impact of economic numbers on the market. Economists gather
and announce their estimates on what the numbers should be to the press. If the estimates are in-line with
the actual figures, the market is said to have “priced in” the numbers, and will often barely react when the
official announcement is made.
However, if the estimates and the actual figures don't match up, extreme market moves can take place
while the market attempts to make up for being fundamentally mispriced. This will often result in an extreme
move where the market resets itself to be in-line with the actual figures.

No economic number plays into the above scenario more than the US Non-Farm Payroll (NFP) release.

First off, let’s identify what the number actually represents.

Non-Farm Payrolls refers to monthly survey data released by the U.S. Department of Labor Statistics at
8:30 a.m. Eastern time on the first Friday of every month. The report estimates the total number of paid
workers in the US, excluding those working in:

The Government

Private household employees

Non-profit organizations

Farm Workers

Together, "nonfarm" employees produce about 80% of U.S. GDP (Gross Domestic Product).

To obtain these statistics, the U.S. Department of Labor Bureau of Labor Statistics, surveys about 160,000
businesses and government agencies, representing approximately 400,000 individual worksites, in order
to provide detailed industry data on employment, hours, and earnings of workers on the payroll.

Below is a chart showing the NFP numbers from February 2008 through October 2009.

Increases or decreases in nonfarm payroll data are used as an indicator of US economic health, since the
report shows whether U.S. businesses are adding to or subtracting from the job pool.

Nonfarm Payrolls has proven itself to be one of the most significant fundamental indicators in recent U.S.
history. As a report of the number of new jobs created outside the farming industry each month, a positive
or negative NFP can get traders to act very hastily. A better-than-expected figure is often very bullish for
the US dollar, whereas a worse number usually results in traders referencing themselves to another
component of unemployment released on the same day: The Unemployment Rate.
Unemployment measures the amount of people that are out of a job, but are actively seeking one. It tends
to be the more politically important number. If this number is smaller, then it means that the people that
are seeking jobs are finding them, possibly meaning that businesses are doing well and that the economy
is expanding. The NFP is a number, usually 5 or 6 figures, whereas the Unemployment Rate is a
percentage. If the NFP comes in better than expected, then traders will tend to buy dollars. However,
should it come in worse than expected, they will look at the Unemployment Rate to check whether or not
the change in unemployment was either positive, negative, or unchanged. If it increased, dollar
bearishness would be confirmed. If it decreased, dollar buying would often ensue. If it was unchanged,
then mild dollar bearishness could be started by adamant dollar bears. It is difficult to trade the NFP and
Unemployment Rate only because many times traders will not pay attention to what seems to be the most
significant components, but will instead focus in on what reinforces their bias. The release typically causes
a significant amount of volatility in the markets. Also there are often revisions to the previous month's
numbers that come out at the same time and can also vary widely.

As might be interpreted from the above, trading this number can be quite challenging. While some traders
look forward to the first Friday of every month with eager anticipation, others shut their trading station down
at sometime Thursday night prior to the announcement, wanting nothing to do with this volatility.
For a visual of the potential volatility, take a look at a 5 minute EURUSD chart below at the time of the
October 2009 release. The announcement took place at the arrow labeled “NFP Announced”. Note that
within the first 5 minutes the pair spiked down 60 pips and then ultimately traded up 160 pips from that
spike. It is the nature of this volatility that many traders wish to avoid.

NFP’s is an important economic number and therefore has the greatest potential to move the market of all
the other economic releases. Many traders can make or break their month in the short time following this
release. NFP’s importance can be broken into two parts. Firstly, the employment number is one of the
best gauges of economic growth and more importantly, the potential for future growth. The Fed watches
this number closely as a leading indicator for the economy. Secondly, many traders actually wait for after
the NFP is released (regardless of what the number is) before entering into trades, just to make sure that
are no surprises for their position.

It is important to note that there is generally very little liquidity at the time of NFP release. This is because
hardly any of the big banks are in the market at those times. Liquidity is like an ocean suddenly shrinking
to the size of a wading pool during the release. Sometime later, the liquidity generally returns to
normal. Many other major news events can have a similar reaction, though few tend to be as volatile as
the NFP.
FOMC (Federal Open Market Committee) is the branch of the United States Federal Reserve that
determines the course of monetary policy. FOMC announcements inform everyone about the US Federal
Reserve's decision on interest rates and are one of the most anticipated events on the economic calendar.
The FOMC may decide to increase, decrease or keep interest rates steady, having a tremendous effect on
currency values. The FOMC's Board of Governors is composed of seven members and five reserve bank
presidents.

What is the US Dollar Index & why it is Important?

The US Dollar Index – known as USDX, DXY, DX and USD Index – is a measure of the value of the United
States Dollar (USD) against a weighted basket of currencies used by US trade partners. The index will rise
if the Dollar strengthens against these currencies and fall if it weakens. Keep reading to learn more on the
US Dollar Index, how it is calculated, and what affects it price.

WHAT IS THE USD INDEX?

The US Dollar Index was started by the Federal Reserve in 1973 and has been managed by ICE Futures
US since 1985. It compares the value of the US Dollar against six currencies used by major US trade
partners – the Euro (EUR), Japanese Yen (JPY), Pound Sterling (GBP), Canadian Dollar (CAD), Swedish
Krona (SEK) and Swiss Franc (CHF).

Before the Euro, the index also included five other European currencies. The Euro accounts for 57.6% of
the weighted value (the same total percentage as the currencies it replaced); the Japanese Yen 13.6%; the
Pound Sterling 11.9%; the Canadian Dollar 9.1%; the Swedish Krona 4.2%; and the Swiss Franc 3.6%.

The US Dollar Index was given a base value of 100.000 when it started. This means a value of 90.000
represents a -10% drop in the value of the Dollar relative to the currencies in the basket (90.000 - 100.000),
while a value of 110.000 represents a +10% rise (110.000 - 100.000).

HOW IS THE US DOLLAR INDEX CALCULATED?

The US Dollar Index is calculated according to the following formula, which includes a USD cross for each
of the six currencies in the basket:

Here we can see that USD is the base currency in four of the six currency pairs included, with these given
a positive value for the purposes of the calculation. The Euro and Pound are the base currency for the two
others, with these given a negative value.

WHY IS THE US DOLLAR INDEX IMPORTANT FOR TRADERS?

The US Dollar Index is important for traders both as a market in its own right and as it is an indicator of the
relative strength of the US Dollar around the world. It can be used in technical analysis to confirm trends
related to the following markets, among others:

• Commodities priced in USD

• Currency pairs that include the US Dollar (such as the ones used to calculate the index’s value)
• Stocks and indexes.
Commodity prices tend to fall (at least nominally) as the Dollar increases in value – and vice versa. Currency
pairs, on the other hand, generally move in the same direction as the Dollar Index if USD is the base
currency, and opposite direction if it is the quote currency – though these ‘rules’ do not always hold true.

For stocks and indexes the picture is more complicated, though US exporters would generally find that their
exports are less competitive internationally when the Dollar is strong, and more competitive when it is
weaker – with their share prices often moving to reflect changes in the Dollar’s value.

Many traders also use the index to hedge risk – for example, offsetting some of the risk associated with a
long USD/JPY trade by going short on the Dollar Index.

A BRIEF HISTORY OF THE US DOLLAR INDEX

In the 1970s, the index fluctuated between 80 and 110 as the US economy struggled through recession
and rapidly rising inflation. As the Federal Reserve increased interest rates to cut inflation in the late 1970s,
money flowed into the US Dollar – causing the USD Index to surge. It reached 164.720 in February 1985,
its highest ever level (as of 24 October 2018).

However, such a strong Dollar caused problems for US exporters, who found that their goods were no
longer as competitive internationally. As a result, the US government took action to make the currency more
competitive with five countries agreeing to manipulate the Dollar in the forex markets as part of the ‘Plaza
Accord’. The US Dollar Index fell by 51% over the next four years.

Since then, the US Dollar Index has tracked economic performance and liquidity flows. For example, it rose
as the current account generated a surplus in the 1990s, fell as US debt levels increased in the 2000s, and
rallied as investors flocked to the relative safety of the Dollar during the Great Recession.

The below chart shows some of the major events that affected the USDX price since 2005.
WHAT AFFECTS THE PRICE OF THE USD INDEX?

The USD Index is affected by the supply of and demand for the US Dollar and currencies that make up the
basket – as these factors influence the price of each currency pair in the formula used to calculate the US
Dollar Index’s value.

Supply and demand for currencies is heavily influenced by the monetary policies – particularly the interest
rates – set by the central bank in each country. Other factors include inflation, economic performance, credit
ratings, market sentiment and foreign affairs.

How to trade US Dollar Index: Trading Strategies and Tips

Trading the Dollar Index (DXY) is a valuable skill as it’s one of the most popular currency indexes
worldwide. In this guide we explore the best tips and strategies for using the dollar index to trade forex,
including an overview of the Dollar Smile Theory and Dollar Index trading hours.

WHAT IS THE US DOLLAR INDEX AND WHY TRADE IT?

The Dollar Index measures the performance, or value, of the US Dollar versus a basket of foreign
currencies. These are trading partners to the US and include the Euro, Japanese Yen, British
Pound, Canadian Dollar, Swedish Krona and Swiss Franc.

Since it is an index, the USD index functions similarly to the FTSE 100 or NYSE but, instead of being a
barometer for the health of the equity market, it shows the relative strength of the US Dollar. The index is
maintained and published by Intercontinental Exchange Inc (ICE) and is calculated every 15 seconds.

Currencies that make up the US Dollar Index

CURRENCY WEIGHT
Euro (EUR) 57.6%
Japanese Yen (JPY) 13.6%
British Pound (GBP) 11.9%
Canadian Dollar (CAD) 9.1%
Swedish Krona (SEK) 4.2%
Swiss Franc (CHF) 3.6%

Source: Bloomberg data

Why trade the US Dollar Index?

The US Dollar is the world’s reserve currency, which means that it is widely traded and attracts interest
from traders all around the globe. It is also an ideal currency to gain exposure to the forex market as it
appeared on one side of 88% of forex trades in April 2016, according to the 2016 BIS Triennial Central
Bank Survey.

The US Dollar has a rather unique characteristic in that it has the tendency to rise in times of global market
uncertainty, but also when the US economy is thriving. As a result, the US Dollar forms long and well-
established trends that skilled traders are able to take advantage of. The remainder of this article focuses
on how to trade such trends and introduces the Dollar Smile Theory which provides an explanation for the
existence of trends in the US Dollar.
US DOLLAR INDEX TRADING STRATEGY

There are many different strategies that traders employ when trading the Dollar Index and these will vary
depending on the type of trader and the strategy implemented. The most widely used trading strategies
incorporate the use of trends, channels, price action (candlestick analysis) and breakouts. Keep reading to
find out more about these strategies and how trend trading can help traders get into and out of higher
probability trades.

Trend Trading the US Dollar Index (DXY)

Being the world’s reserve currency, the Dollar tends to form long and well-established trends. Trend trading
is one of many strategies adopted by forex traders looking for signals to enter the market in line with the
dominant trend.

In the chart below, it is clear to see the long periods where a trend has established itself. This is
characterized by periods of higher highs and higher lows (the upward sloping green line) and long periods
of lower highs and lower lows (the downward sloping red line).

US Dollar Index showing periods of well-established trends (August 2016 – November 2018)

A common approach to trend trading involves identifying the long term trend and then looking for ideal entry
points with the use of an indicator, using a smaller time frame or simply by reading price action.

For example, the chart below shows confirmation of a downtrend after the US Dollar market topped. This
downtrend forms by observing lower highs and lower lows, as indicated by the blue circles. Confirmation of
the downtrend occurs when the market trades to a lower low after producing a lower high. At this point, only
trades in the direction of the trend should be considered. This is particularly important when using an
indicator because an indicator has no concept of trend and may provide weak signals if not filtered with the
trend’s direction.
Confirmation of downtrend on US Dollar Index (Daily chart)

Swing traders make use of multiple time frame analysis when looking to time their entries into a trade. The
longer time frame (daily chart) allows the trader to establish the overall trend. Zooming in on the chart using
a smaller time frame (four-hourly chart), will provide the trader with higher probability entry signals when
they are aligned with the trend.

Now that the downtrend has been established, we can look for entries to sell (depicted in the red zone).

US Dollar Daily chart highlighting the zone applicable for short trades
The chart below shows the red highlighted zone using the four-hour chart and incorporates the stochastic
indicator to provide entry signals. The stochastic provides many entry points which is why it is essential to
filter these signals in order to achieve higher probability trades.

Stochastic indicator providing possible entry points (4 hour chart)

Checklist when using the stochastic to enter trades:

1. Trend: Only consider signals that are in the direction with the current longer-term trend.
2. Crossovers: Look for the trigger point when the %K line crosses the lagging %D line. This
indicates that momentum is slowing down and could change direction.
3. Extreme Levels: To enhance the strength of the signal, only consider crossovers at extreme levels
i.e. when the market is overbought (above the 80 level) and oversold (below the 20 level).

In this example, we would only consider entries corresponding with the red circles on the stochastic
indicators and should disregard the buy signals (grey circles) as these signals move against the current
trend.
As always, it is important to make use of sound risk and money management before entering a trade to
ensure your account is able to withstand losing trades along the way.

Typically, after traders enter the market, they place a stop loss just above the recent swing high for a short
trade or just below the swing low on a long trade. Where exactly, a trader enters the market, will differ from
trader to trader but there are several essentials that should be implemented consistently. One such
essential is that the take profit and stop losses should be placed in accordance with a positive risk to reward
ratio which can be a 1:1 or preferably, 1:2 if possible. For example, if the distance from entry to the stop
loss is 50 points, then the take profit target should be 100 points away from the entry level in a 1:2 risk to
reward set up.

Additionally, it is prudent to keep individual trades to a maximum of 1% of the trading account. This is a
simple way to ensure that only high probability trades are entered into and has the added benefit of
absorbing losses along the way without jeopardizing the trading account.

THE DOLLAR SMILE THEORY AS A LONG-TERM TRADING STRATEGY

The Dollar Smile Theory was first observed by Stephen Jen, a former currency strategist and economist at
Morgan Stanley. It attempts to explain why the US Dollar strengthens in periods when the US economy is
thriving, as well as, in periods of worsening global economic conditions. The pattern resembles a smile and
plays out in three stages, as shown below.

Stage 1: Fear drives investors towards the less risky US Dollar

When investors become risk averse, they will often turn to “safe havens” such as gold, or in this case, the
US Dollar. The surge in USD purchases drives the price of the dollar up.
Stage 2: USD weakens to new lows (weak US economic conditions)

The lowest point in the smile reflects a weaker US Dollar as a result of strained fundamentals. Sluggish
economic growth could invite interest rate cuts, further weakening the currency.

Stage 3: US Dollar strengthens due to economic growth

The smile is completed as signs of an economic recovery appear. Investors buy into the Dollar once
more, causing an increase in the value of the US Dollar

DOLLAR INDEX TRADING HOURS

US Dollar Index Futures trade 21 hours a day on the Intercontinental Exchange (ICE) and can be traded
through an online forex, CFD and spread betting broker (where allowed). Trading hours may vary slightly
across brokers but typically trades in line with the futures as produced below.

OPEN * CLOSE
ICE US Dollar Index Futures trading hours ET 20:00 17:00 (next day)
GMT 01:00 22:00 (next day)

*The official GMT open starts at 23:00 on Sunday and closes for the week at 22:00 on Friday. Official ET
open starts at 18:00 on Sunday and closes for the week at 17:00 on Friday.