Trading GDP Like A Currency Trader

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Trading GDP Like A Currency Trader

Economic data reports are essential for a foreign exchange (forex) trader. These significant economic statistics produce volatility, and much of conjecture is usually around them, and The United States’ gross domestic product (GDP) is one such report. Not only doforex(FX) traders continue to monitor this important piece of economic data, they use it to either establish a new position or support a current one.

What Goes into the GDP Report

Gross domestic product is simply the totalmarket valueof all goods and services produced in a particular country. In the case of the United States, this total can be broken down into four main categories: consumption, investment, government expenditures (or spending) and net exports.

  • Consumption: Households’ final consumption expenditures. Food, rent, gas, and other personal expenses are examples of them.
  • Investment includes both business expenditure on new facilities and equipment and family property investment.
  • Government expenditure and investment: The sum of all government spending, including pay for public employees and military or social program benefits.
  • Total final exports minus total imports equals net exports. A greater net export figure is more beneficial to the economy.

The sum of these numbers is the United States’ total gross domestic product, which can be compared to another year’s performance in order to derive a percentage of GDP growth or contraction in a particular period.

Making the Comparison

Gross domestic product figures can be released on a monthly or quarterly basis. For the United States, the Bureau of Economic Analysis (BEA), a branch of the U.S. Commerce Department, releases final quarterly domestic figures—along with additional advanced or preliminary figures toward the end of each month. This report can also be released in either real or nominal conditions, the former being adjusted for the effects of inflation. The BEA also releases its GDP price index that has been used in competition with both consumer price index (CPI) and the personal consumption expenditures deflator as agaugeof consumer inflation.

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Trading the Foreign Exchange Markets

The gross domestic product report, like any other piece of crucial economic data, has a lot of weight for currency speculators. It demonstrates expansion in a productive economy while signifying decline in a deteriorating one. As a consequence, currency speculators will likely to seek greater GDP or growth rates in the expectation that interest rates would follow suit. When an economy grows at a healthy pace, the advantages flow down to the consumer, boosting the possibility of spending and expansion. In turn, more spending leads to higher prices, which central banks seek to control by raising interest rates.

Although there are three versions—advanced, preliminary, and final—the relationship between them is more significant than the individual releases. When trading currencies, currency specialists will emphasis sophisticated reading. They will, however, not ignore any disparities when comparing the advanced with both the preliminary and final readings.

A final reading of 1.5% growth compared to a previous advanced release of 3.5% is worse off than a comparable 1.5% print in both advanced and final readings. Positive growth is usually beneficial to the economy, but not when the final GDP number falls below the advanced estimate.

What Investors Can Expect

A trader or investor might fairly anticipate three fundamental responses to price action:

1.A lower-than-expected GDP figure will almost certainly cause the native currency to fall in value compared to foreign currencies. In the instance of the United States, a lower GDP number would indicate an economic contraction and reduce the likelihood of an increase in US interest rates, decreasing the value or attractiveness of US dollar-based assets. Furthermore, the dollar falls sharply the farther an actual GDP number deviates from the estimate.

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2.An anticipated reading necessitates a little more comparison on the part of the FX investor. The analyst or trader will want to compare the current data to the prior quarter’s reading—and maybe the previous year’s reading—at this point. This allows for a more accurate assessment of the problem. Given this element, the resultant price action is likely to be mixed as the market irons through the specifics.

3.A figure that is greater than anticipated tends to boost the underlying currency in comparison to other currencies. As a result, a higher US GDP number will benefit the greenback, contributing to some dollar appreciation versus other currencies; the higher the real GDP reading, the steeper the gradient of the dollar’s appreciation.

Putting It All Together

So, let’s take a quick look at a recent example:

EUR/USD reacts to the U.S. GDP release on March 28, 2011. Image by Sabrina Jiang © Investopedia2020

Over the last few sessions, the EUR/USD currency pair has fallen from the 1.4200 large figure (far right-hand side of the chart) to establish support slightly below 1.4050 in the 60-minute time frame. Take note of how the euro rose by around 50 pips soon after the March 28, 2011, announcement at 8:30 a.m. At the time, it was announced that the world’s biggest economy expanded at a slower rate than anticipated. Instead of gaining by a projected 1.9%, the United States advanced by just 1.8%. This was also smaller than the previous quarter’s 3.1%, indicating a visible slowing in growth. As a consequence, traders sided with selling a weaker US dollar, allowing the euro to recoup its losses and break past the 1.4200 resistance level.

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To take advantage of this opportunity, a forex trader might simply put a buy entry at the support level, with a reasonably tight stop order of 30-40 pips for risk management.

The Bottom Line

When it comes to trading the foreign currency markets, the US gross domestic product (GDP) data is – and will likely continue to be – a significant release to consider. The traders who understand how to analyze this data and apply its significance to a specific transaction will come out on top.

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