Forex Walkthrough

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Short Term - Non-Farm Payroll

The non-farm payroll (NFP) report is a key economic indicator for the United States. It is intended to represent the total number of paid workers in the U.S. minus farm employees, government employees, private household employees and employees of nonprofit organizations.

The NFP report causes one of the consistently largest rate movements of any news announcement in the forex market. As a result, many analysts, traders, funds, investors and speculators anticipate the NFP number - and the directional movement it will cause. With so many different parties watching this report and interpreting it, even when the number comes in line with estimates it can cause large rate swings. Read on to find out how to trade this move without getting knocked out by the irrational volatility it can create. (For background reading, see A Guide To Conference Board Indicators.)


Trading News Releases
Trading news releases can be very profitable, but it is not for the faint of the heart. This is because speculating on the direction of a given currency pair upon the release can be very dangerous. Fortunately, it is possible to wait for the wild rate swings to subside. Then, traders can attempt to capitalize on the real market move after the speculators have been wiped out or have taken profits or losses. The purpose of this is to attempt to capture rational movement after the announcement, instead of the irrational volatility that pervades the first few minutes after an announcement. (For more, see Trading On News Releases.)

The release of the NFP generally occurs on the first Friday of every month at 8:30am EST. This news release creates a favorable environment for active traders in that it provides a near guarantee of a tradable move following the announcement. As with all aspects of trading, whether we make money on it is not assured. Approaching the trade from a logical standpoint based on how the market is reacting can provide us with more consistent results than simply anticipating the directional movement the event will cause. (For related reading, see Economic Indicators For The Do-It-Yourself Investor.)

The Strategy
The NFP report generally affects all major currency pairs, but one of the favorites among traders is the GBP/USD. Because the forex market is open 24 hours a day, all traders have the capability to trade the news event.


The logic behind the strategy is to wait for the market to digest the information's significance. After the initial swings have occurred, and after market participants have had a bit of time to reflect on what the number means, we will enter a trade in the direction of the dominating momentum. We wait for a signal that indicates the market may have chosen a direction to take rates. This helps avoid getting in too early and decreases the probability of being whipsawed out of the market before it has chosen a direction.

The Rules
The strategy can be traded off of five- or 15-minute charts. For the rules and examples, a 15-minute chart will be used, although the same rules apply to a five-minute chart. Signals may appear on different time frames, so stick with one or the other.

  1. Nothing is done during the first bar after the NFP report (8:30-8:45am in the case of the 15-minute chart).
  2. The bar created at 8:30-8:45 will be wide ranging. We wait for an inside bar to occur after this initial bar (it does not need to be the very next bar). In other words, we are waiting for the most recent bar's range to be completely inside the previous bar's range. (For a variation of this strategy, see Inside Day Bollinger Band® Turn Trades.)
  3. This inside bar's high and low rate sets up our potential trade triggers. When a subsequent bar closes above or below the inside bar, we take a trade in the direction of the breakout. We can also enter a trade as soon as the bar moves past the high or low without waiting for the bar to close. Whichever method you choose, stick to it.
  4. Place a 30-pip stop on the trade you entered. (For more, see A Logical Method Of Stop Placement.)
  5. Make up to a maximum of two trades. If both get stopped out, don't re-enter. The inside bar's high and low are used again for a second trade if needed.
  6. Our target is a time target. Generally, most of the move occurs within four hours. Thus, we exit four hours after our entry time. A trailing stop is an alternative if traders wish to stay in the trade.

Example


Figure 1: February 6, 2009. GBP/USD 15-minute chart. Time is GMT.
Source: Forexyard


Looking at Figure 1, the vertical line marks the 8:30am EST release of the NFP report. As you can see from the chart, there are three bars, or 45 minutes, of back-and-forth action following the release. During this time, we do not trade until we see an inside bar. The inside bar has a square around it on the chart. This bar's price range is fully contained by the previous bar. We will enter when a bar closes higher or lower than the inside bar. The next bar's close is circled, as that is our entry; it closed above the inside bar's high. Our stop is 30 pips below the entry price, which is marked by a solid black horizontal bar.

Because our entry occurred at approximately at 9:45am EST (2:45pm GMT), we will close out our position four hours later. By entering the trade at 1.4670 and exiting four hours later at 1.4820, 150 pips were captured while risking only 30 pips. However, it should be noted that not every trade will be this profitable. (Before attempting to trade any strategy, be sure to read Stimulate Your Skills With Simulated Trading.)

Strategy Downfall
While this strategy can be very profitable, it does have some pitfalls to be aware of. For one, the market may move in one direction aggressively and thus may be beginning to fade by the time we get an inside bar signal. In other words, if a strong move occurs prior to the inside bar, it is possible a move could exhaust itself before we get a signal. It is also important to note that in high volatility times, even after waiting for a pattern setup, rates can reverse quickly. This is why it very important to have a stop in place.


Summary
The logic behind this strategy of trading the NFP report is based on waiting for a small consolidation, the inside bar, after the initial volatility of the report has subsided and the market is choosing which direction it will go. By controlling risk with a moderate stop we are poised to make a potentially large profit from a huge move that almost always occurs each time the NFP is released.

Why Medium Term?
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