TRADING BEFORE REPORTS

TRADING BEFORE REPORTS
Here are the major reports that have created dramatic and violent price
swings in currencies. I want you to have a good understanding of what they
mean so you can relate possible shocks to the markets when and if they are
dramatically changed from what is expected before the reports’ release.
• Employment Cost Index (ECI). This is a measure of total employee
compensation costs, including wages, salaries, and benefits. The ECI is
the broadest measure of labor costs. The employment cost index helps
analysts determine the trend of the direction of employers’ cost of having
employees. This can give economists a clue whether inflation is
perking up from a cost-of-doing-business standpoint. If a company
needs to pay more to hire qualified workers, then the cost of doing
business increases. This reduces profit margins. Companies usually
raise their prices to consumers if their costs increase, and that is where
the inflation theme plays out.
• Producer Price Index (PPI). This is a measure of the average prices
paid by producers for a fixed basket of capital and consumer goods.
The PPI measures price changes in the manufacturing sector. Inflation
is a general increase in the prices of goods and services.
• Consumer Price Index (CPI). This is a measure of the average price
level of goods and services purchased by consumers. Monthly changes
in the CPI represent the rate of inflation. The consumer price index is
the most widely followed indicator of inflation in the United States.
Just knowing what inflation is and how it influences the markets can
put an investor ahead of the game. Inflation is a general increase in the
price of goods and services. The relationship between inflation and interest
rates is the key to understanding how data like the CPI influence
the markets. Higher energy prices, manufacturing cost increases, med-
The Business of Trading Money 47
ical costs, and imbalances in global supply and demand of raw materials
and food products all weigh on this report. Take the price of gasoline
we pay at the pumps. If gas prices escalate to the point where it
costs $30 to fill up a car, or $60, or even $100, as was the case in 2006,
consumers will have less spending money for other items. Even
weather can be a factor on short-term changes on food. What would be
the cost of tomatoes at the grocery store after a damaging freeze in California
or in Georgia—$3 or $4 per pound? It has occurred. Think of the
restaurants that serve salads and lose revenue, let alone the farmer
whose crop is destroyed. This all plays a part in the CPI number. The
core rate is the inflation number that excludes the volatile food and energy
components.
• Gross Domestic Product (GDP). This is the broadest measure of aggregate
economic activity and accounts for almost every sector of the
economy. Analysts use this figure to track the economy’s performance
because it usually indicates how strong or how weak the economy is,
and that helps predict the potential profit margin for companies. It also
helps analysts gauge whether the economy is accelerating or slowing
down. The stock market likes to see healthy economic growth because
that translates to higher corporate profits.
• Industrial Production and Capacity Utilization Rate. This is a measure
of the physical output of the nation’s factories, mines, and utilities.
The capacity utilization rate reflects the usage of available resources
and provides an estimate of how much factory capacity is in use. If the
utilization rate gets too high (above 85 percent), it can lead to inflationary
pressures. Industrial production shows how much factories,
mines, and utilities are producing. Since the manufacturing sector is
estimated to account for one-quarter of the economy, this report
can sometimes have a big impact on the stock and financial markets’
movement.
• Index of Leading Indicators. This report is a composite index of 10
economic indicators that typically lead overall economic activity. The
Index of Leading Indicators helps to predict the health of the economy,
such as recessions and economic expansions.
• International Trade. This measures the difference between imports
and exports of both goods and services. Changes in the level of imports
and exports are an important tool that is used to gauge economic
trends both here and overseas. This report can have a profound effect
on the value of the dollar. That in turn can help or hurt multinational
corporations whose profits overseas can diminish when they convert
their funds back to the United States, especially if the U.S. dollar is
overvalued. Another valuable aspect of this report is that imports can
48 FOREX CONQUERED
help indicate demand for foreign goods here in the United States and
exports may show the demand for U.S. goods in overseas countries.
• Institute of Supply Management (ISM) Index (formerly the National
Association of Purchasing Managers [NAPM] Survey). This survey is
a composite diffusion index of national manufacturing conditions.
Readings above 50 percent indicate an expanding factory sector. The
ISM Index helps economists and analysts get a detailed look at the
manufacturing sector of the economy. Since manufacturing is a major
source of strength for the economy and can reflect the nation’s employment
condition, this report is very important to watch.
• Factory Orders. This reports the dollar level of new orders for manufacturing
durable and nondurable goods. The data from this report
shows the potential that factories will be increasing or decreasing activity
based on the amount of orders they receive. This report provides
insight to the demand not only for hard goods, such as refrigerators and
cars, but also for nondurable items, such as cigarettes and apparel.
• Productivity and Costs. Productivity measures the growth of labor
efficiency in producing the economy’s goods and services. Unit labor
costs reflect the labor costs of producing each unit of output. Both are
followed as indicators of future inflationary trends. Productivity
growth is critical because it allows for higher wages and faster economic
growth without inflationary consequences.
• Consumer Confidence. This is a survey or a poll of consumers’ opinions
regarding both their present conditions and their expectations regarding
their economic conditions. Five thousand consumers across
the country are surveyed each month. The theory here is that the level
of consumer confidence is directly related to the strength of consumer
spending. Consumer spending accounts for two-thirds of the economy.
If consumers are confident that times are good, spending is likely to remain
stable or even to increase. If consumer confidence is weak, then
more times than not consumers save and do not spend money. This
shift in spending habits can help or hurt the developments in the economy
from durable goods sales to home or car purchases. If consumers
are not confident, then they are less likely to purchase those big-ticket
items.
• Personal Income and Spending. Personal income is the estimated
dollar amount of income received by Americans. Personal spending is
the estimated dollar amount that consumers use for purchases of
durable and nondurable goods and services. This economic number is
important because if consumers are spending more than they make,
eventually the spending will stop, thus causing a downturn in the economy.
Another aspect to consider is consumers who save, maybe in-
The Business of Trading Money 49
vesting in the markets, and that can increase the value of stock prices.
In addition, it can also add liquidity to the banking system if the money
goes to savings or money market accounts.
• Durable Goods Orders. These reflect new orders placed with domestic
manufacturers for immediate and future delivery of factory-made
products. Orders for durable goods show how busy factories will be in
the months to come as manufacturers work to fill those orders. The
data provides insight into demand for things like washers, dryers, and
cars and also takes the temperature of the strength of the economy
going forward.
• Retail Sales. These measure the total sales at stores that sell durable
and nondurable goods. This can reveal the spending habits of consumers,
and the trend of those spending “sprees” can more often than
not influence analysts’ expectations for future developments to the
economy.
• Construction Spending. This report shows analysts the amount of
new construction activity on residential and nonresidential building
jobs. Prices of such commodities as lumber are sensitive to housing industry
trends. In addition, business owners usually will put money into
the construction of a new facility or factory if they feel confident that
business is good enough to validate an expansion.
• Housing Starts. This is a measure of the number of residential units
on which construction is about to start. The backbone of the U.S.
economy is construction. Think about this: When you purchase a new
home, you probably also purchase durable items, like refrigerators,
washers and dryers, furniture, and lawn care products. This is known
as a ripple effect throughout the economy. Think of all the jobs produced
from construction to factory and transportation and even to
communication and technology that goes into the building and financing
and furnishing of a new home. The economic commerce is substantial,
especially when there are a hundred thousand or more homes
built in a month around the country. At the very least, the data from
housing starts can help project the price direction for the sector of
stocks in homebuilders, mortgage banks, and appliance companies. It
used to be that lumber and copper futures prices were dramatically affected
by the Housing Starts figure. However, since the development of
prefabricated and new construction materials, especially fiber optics
and plastics (PVC is used for plumbing rather than copper), lumber
and copper are now less sensitive to the building industries’ trends.
• Mortgage Bankers Association Purchase Applications Index. This is
a weekly index of purchase applications at mortgage lenders. This is a
good leading indicator for single-family-home sales and housing construction.
It provides a gauge of not only the demand for housing but
50 FOREX CONQUERED
also economic momentum. Each time the construction of a new home
begins, it translates into more construction jobs and income, which
will be pumped back into the economy.
• New Home Sales. This is the number of newly constructed homes
with a committed sale during a month. The level of new home sales indicates
housing market trends. This provides a gauge of not only the
demand for housing but also economic momentum. People have to be
feeling pretty comfortable and confident in their financial position to
buy a house. Furthermore, this narrow piece of data has a powerful
multiplier effect throughout the economy and, therefore, across the
markets and your investments. By tracking economic data such as new
home sales, investors can gain specific investment ideas as well as
broad guidance for managing a portfolio. Each time the construction of
a new home begins, it translates to more construction jobs and income,
which will be pumped back into the economy. Once the home is sold,
it generates revenues for the home builder and the realtor. It brings a
myriad of consumption opportunities for the buyer. Furniture and large
and small appliances are just some of the items new home buyers
might purchase. The economic ripple effect can be substantial, especially
when a hundred thousand new households around the country
are doing this every month. Since the economic backdrop is the most
pervasive influence on financial markets, new home sales have a direct
bearing on stocks, bonds, interest rates, and the economy in general. In
a more specific sense, trends in the new home sales data carry valuable
clues for the stocks of home builders, mortgage lenders, and home furnishings
companies.
• Existing Home Sales. This is the number of previously constructed
homes with a closed sale during the month. Sales of existing homes
(also known as home resales) are a larger share of the market than new
homes and indicate housing market trends. This provides a gauge of
not only the demand for housing but also economic momentum. People
have to be feeling pretty comfortable and confident of their own financial
situation to buy a house. Analysts follow economic data such as
home resales because this generates a tremendous economic ripple effect.
Even for existing homes, buyers may purchase new refrigerators,
washers, dryers, and furniture.
• Consumer Credit. This report measures consumer credit that is outstanding.
Since one of U.S. consumers’ pasttimes is to “charge” goods
and services to their credit cards, the overall changes in consumer
credit can indicate the condition of individual consumer finances. On
one hand, economic activity is stimulated when consumers borrow
within their means to buy cars and other major purchases. On the other
hand, if consumers pile up too much debt relative to their income lev-
The Business of Trading Money 51
els, they may have to stop spending on new goods and services just to
pay off old debts. That could put a big dent in future economic growth.
The demand for credit can also have a direct effect on interest rates. If
the demand to borrow money exceeds the supply of willing lenders, interest
rates rise. If credit demand falls and many willing lenders are
fighting for customers, they may offer lower interest rates to attract
business.
• Business Inventories. Alan Greenspan watched this report; you
should become familiar with it as well. This report shows the dollar
amount of inventories held by manufacturers, wholesalers, and retailers.
The level of inventories in relation to sales is an important indicator
for the future direction of factory production.
• Consumer Confidence. There are several such surveys that gauge
consumer attitudes; one is the Conference Board, and another is the
University of Michigan. These reports reveal both the present situation
and expectations regarding economic conditions. The level of consumer
confidence is generally assumed to be directly related to the
strength or weakness for consumer spending. Generally speaking,
the more confident consumers are about their own personal finances,
the more likely they are to spend. Think of how you act and feel as a
“consumer.” If you have money in the bank and feel confident that your
job is secure, buying an extra gadget or splurging on a night out usually
won’t be trouble, right? But if times are tough, then the purse strings
get pulled in, correct?
HOT TIP
Get a calendar of events; check it every day to find out which reports will be released
and at what time. Also be aware if there are scheduled speakers, such as
heads of central banks, the president, or voting members of the FOMC. Make
sure you converted these report release times for the time zone in which you
live and trade. That way you will be prepared and not hit with an unexpected
news-driven, price-shock event.
WHEN IS THE BEST TIME TO TRADE?
Forex traders use fundamental analysis as described earlier to identify trading
opportunities by analyzing economic information for a longer-term perspective.
Short-term traders should also understand which reports can
cause a shift in currency markets and know when they are released.
Knowing the best times to trade the markets will help you nail down
52 FOREX CONQUERED
when a potential trade may materialize. The pie chart in Figure 1.4 showed
that the largest percentage value traded against the U.S. dollar was the
euro; therefore, that suggests that one of the highest-volume time periods
would be when the European session opens. The central place of foreign
currency dealings is in London, where the second-most-active trading volume
occurs (the U.S. session being the first). Therefore, London is where
there are likely to be large-range swings in the market granting day traders
an opportunity to profit. That session begins at 3 A.M. (EST) and goes until
11:30 A.M. (EST). So a euro to U.S. dollar (EU/USD) or euro to British pound
(EU/BP) or British pound to U.S. dollar (BP/USD) pair would be an appropriate
selection to trade during the European session. The U.S. session
opens at 8 A.M. (EST), which overlaps the European session; these two sessions
combined generate the bulk of trading activity. Most major U.S. economic
reports are released at 8:30 A.M. (EST); and, as expected, the
currency markets generally react off those reports. This offers traders the
opportunity to trade off violent price spikes when economic news is released,
especially when the news is a surprise.
Once the U.S. markets close at 5 P.M. (EST), the currency markets are
available to trade; but it is not until the Asian session opens at 7 P.M. (EST)
that markets will experience potential price swings as volume levels
rise. During the Asian session, traders would want to focus on the Australian
dollar and the Japanese yen and the trade opportunities offered by
the USD/JY or the USD/AUS or the cross pair trading the JY/AUS dollar. Notice
that the Asian markets overlap the European session as well, so the
Japanese yen versus the euro cross (JY/EU) is a popular pair to trade. Table
1.5 shows the time zones on which you want to focus when trading spot
forex markets.
Forex Traders Can Benefit from Futures Data
Forex traders can integrate futures data to help in trading decisions, such
as taking a trading signal based on chart patterns in the futures and trans-
The Business of Trading Money 53
TABLE 1.5 Trading Times for Forex
Trade Session Eastern Time Greenwich Mean Time
Asian open 7:00 P.M.23:00
Asian close 4:00 A.M.08:00
London open 3:00 P.M.07:00
London close 11:00 A.M.15:30
U.S. open 8:00 A.M.12:00
U.S. close 5:00 P.M.21:00
lating it into a trading trigger signal in a forex market. Spot FX and futures
trade in tandem, and any price difference is called the “basis”; both FX and
futures generally trade, pricewise, equally on a day-to-day basis (within a
few PIPs). As we discussed previously, forex markets are decentralized, so
there is not a collective database to measure two distinct studies, such as
volume and open interest. These are important tools, so let’s review the basics.
If you are just using your FX dealer’s trading platform for charts and
quotes, you will not be able to get the volume and open interest information.
However, you need only end-of-day data, and you can search the Internet
for end-of-day charting data for futures markets. If you do subscribe
to a charting software company, then it can add end-of-day charts for nothing
or a very nominal monthly charge.
Volume
At this point, it is important to define what the volume figures are that you
can receive and analyze in the forex market. The volume for forex pairs represents
the number of transactions or ticks and not true trade-size activity.
Forex does not have actual trade-size information because there is not a
central marketplace to tabulate and send the information out to traders.
The true definition of volume is the number of trades for all the total contract
months of a given future’s contract, both long and short, combined.
For example, the futures foreign currency markets trade on quarterly expirations—
the March, June, September, and December contract months. The
volume will represent the total for all the trades in each contract month.
Most technical analysts believe that volume is an indicator of the strength
of a market trend. It is also a relative measure of the dominant behavior of
the market. Here is a further explanation; volume is the measurement of the
market’s acceptance or rejection of price at a specific level and time. There
are several theories and so-called rules when using volume analysis on
price charts; the first one is that if a market is increasing in price and the
volume is increasing, then the market is said to be in a bullish mode and can
indicate a continued move in the direction of the trend.
The exact opposite is true for a declining market. However, if a substantial
daily market price increase or decrease occurs after a long steady
uptrend or downtrend, especially on unusually high daily volume, it is
considered to be a “blow off top or bottom” and can signal a market turning
point or trend reversal. Here are some guidelines to use when using volume
analysis.
• Increasing volume in a rising price environment signals excessive buying
pressure and could lead to substantial advances.
54 FOREX CONQUERED
• Increasing volume in a falling price environment might signal a continual
fall in prices or a prolonged bearish trend.
• Decreasing volume in a rising price environment may indicate a plateau
and can be used to predict a reversal. Especially when prices make a
higher high such as occurs with divergence patterns, a decline in volume
with a rise in prices is extremely bearish.
• Decreasing volume in a weaker price environment shows that fresh
sellers are reluctant to enter the market and could be a sign of a trend
reversal.
• Excessive volume in a high price environment indicates that traders
are selling into strength and often creates a price ceiling.
• Excessively low volume in a low price environment indicates that
traders are buying on weakness and often creates a floor of support.
I want you to study the chart in Figure 1.13; it shows the trends that occurred
in the Japanese yen futures contract. If you recall, earlier in the
book, I gave an example of the confusing aspect of the quotation of yen futures
contracts versus spot forex contracts. Figure 1.13 shows what I was
referring to. The futures contracts are quoted yen to dollar, FX is quoted
dollar to yen. Let’s go over how to interpret the data, and then I will explain
The Business of Trading Money 55
FIGURE 1.13 Japanese Yen Trends (daily bars)
Used with permission of GenesisFT.com.
how you will apply that information to the forex market. Looking at the
chart from left to right, the first trend (point A) condition is down. The corresponding
volume levels are also trending lower. This indicates that, with
the decreasing volume in the weakening price environment, new sellers
are reluctant to enter the market and that a reversal is imminent. As the
market bottoms in late April (point B), the sharp price increase is followed
with a rise in volume, indicating prices can sustain an advance. Finally,
when the high of the move has formed (point C), it is made with a large
bearish engulfing candle pattern. The trend reverses as sellers enter the
market and longs liquidate their positions. Notice that this new downtrend
is on increasing or rising volume, which alerts you that a substantial move
is in the works.
Two Flaws in Volume
As with life or any aspect of trading, nothing is perfect. Collecting and analyzing
volume is no exception, especially in the futures markets. The first
flaw is that the data is delayed by one day. You can get real-time tick volume,
which shows how many times a price level was traded, but not realtime
contract size volume; the exchanges do not post this information until
the following day. There is a huge difference in the two concepts. The second
flaw is that as a futures contract month gets closer to expiration, it converges
with spot prices and becomes the cash market. At that point, it no
longer is a “futures” contract. For example, a September futures contract
expires around the middle of the month by late August traders moving their
positions out of the September and rolling over into the next contract
month, which would be a December contract. As this occurs, the volume
levels start to artificially decline in one month as the further-out contract
month starts to increase. This can be confusing and generate false signals.
HOT TIP
Stay ahead of the crowd! I have a solution and can help you possibly beat the
system! Remember the section on the currency ETFs? They trade in real time;
they track almost identically to the spot currency markets (perhaps even better
compared to forex dealers); and because they are listed on the New York Stock
Exchange, they report real-time transaction volume! The drawback here is that
they only trade during the U.S. equity market session—9:30 A.M.(EST) to 4:00
P.M.(EST).
Let’s examine this principle of using volume analysis from the euro
ETF (FXE) versus the futures market, which is shown in Figure 1.14. The
56 FOREX CONQUERED
first thing that should pop out at you is the fact that the ranges of each bar
(or, in this chart, the candles) are comparatively smaller than the ones in
Figure 1.15, which is a spot forex euro currency. This is because the euro
ETF only trades during the U.S. equity market session. However, if you
compare the price points as shown at point A and point B on both charts,
you will see that the lows and the highs are almost exactly the same. The
volume analysis is easily tracked, and you do not have to account for the
rollover effect that exists in the futures markets. This is a continuous market.
You can easily see where the market declines in price on declining volume;
and as a reversal forms into an uptrend, it is accompanied with an
increase in volume. This again is a very healthy sign that the trend may
maintain more upward momentum. The increase in volume helps amplify
the magnitude of an increase in the value of the euro.
Armed with this information, you can make better decisions for staying
on the long side of the market if you are a day trader. As a swing trader, you
may wish to exploit the potential for a serious price advance. If you are a
position trader, you can develop a solid trading plan with various choices in
strategies or trading vehicles.
Figure 1.15 shows that at point A, we broke below a previous swing
low. Some traders may have looked at that as a sign of continuing weakness
in prices. However, with the aid of volume analysis, the price decline was
The Business of Trading Money 57
FIGURE 1.14 Euro Currency Trust (daily bars)
Used with permission of GenesisFT.com.
on sharply declining volume. That was indicating that sellers were running
out of steam and that a price reversal was imminent. The very low marked
by point A shows a very strong reversal engulfing/piercing candle pattern.
That was a confirming clue that the price decline had ended. If you have
knowledge on the technical analysis theory and combine the use of several
indicators, such as price and volume studies, you will increase your probability
of success.
Open Interest
Open interest reveals the total amount of open positions that are outstanding
and are not offset or delivered on. Remember that in futures trading,
this is a zero-sum game: For every long, there is a short; or for every buyer,
there is a seller. The open interest figure represents the longs or the shorts,
but not the total of both. So when examining open interest, the general
guidelines are that when prices rise and open interest increases, this reveals
that more new longs have entered the market and more new money is
flowing into the market. This reflects why the price increases. Of course,
the exact opposite is true in a declining market. Chartists combine both the
price movement and the data from volume and open interest to evaluate the
condition of the market. If there is a price increase on strong volume and
open interest increases, then this is a signal that there could be a continued
trend advance. The opposite is true for a bear market when prices decline.
Also, if prices increase, volume stays relatively flat or little changed, and
58 FOREX CONQUERED
FIGURE 1.15 Euro/U.S. Dollar (daily bars)
Used with permission of GenesisFT.com.
open interest declines; this then reflects a weakening market condition.
This is considered to be a bearish situation because if open interest is declining
and prices are rising, then this shows that shorts are covering by
buying back their positions rather than new longs entering the market. That
would give a trader a clue that there is a potential trend reversal coming.
Here is a guide as to how to identify an opportunity when there is a major
top or bottom in the spot forex markets using this information: When observing
a continued long-term trend in a spot forex currency in order to
spot a climaxing market condition or reversal of the trend, whether it is in
an uptrend or a downtrend, clues to watch for:
• Prices start to fluctuate with wider-than-normal daily price swings or
ranges, or are in an extremely volatile condition.
• Prices move against the trend accompanies unusually strong volume
and a decline in open interest.
The market is getting ready to turn or reverse the trend.
In Figure 1.16, the graph is a futures euro contract with the volume and
open interest study. The bar graph represents the volume with the open interest
overlaid by plotting a line measurement.
Notice after the peak in prices, the volume started to dry up (decline).
The Business of Trading Money 59
FIGURE 1.16 Euro (daily bars)
Used with permission of GenesisFT.com.
Open interest started to decline confirming a top was in place. This was a
warning that a trend reversal was forming rather than a small correction.
Therefore, spot forex traders would more clearly recognize that selling rallies
and/or looking to take sell signals at resistance would be a more fruitful
and profitable course of action, due to the bearish volume and open
interest signals that the futures markets provided.