One of the most popular (and successful) trading strategies when learning how to forecast forex prices is to use important news events as the driver for preferred trading approaches. But for those still learning how to trade the forex markets, this can seem like a daunting and difficult task. First, we have to know which economic data is going to move market sentiment, and then we have to know how interpret the results once they are released. Let’s look at an example using the British Pound (GBP). Let’s assume the currency is trading in an uptrend right before its monthly Retail Sales data report is released.
In this case, markets are likely expecting a positive number from this release. Assume market analysts have forecast a 2 percent monthly rise and a 1 percent yearly rise for the UK’s Retail Sales report. It should be understood that there is a difference between these two numbers because we are looking at different time frames. The 2 percent rise is expected versus the levels seen in the previous month. The 1% rise is expected versus the levels that we seen in the previous year. This essentially means that Retail Sales were slightly stronger a year ago than they were a month ago.
In any case, we have to assume the market is expecting a positive number — and before the report is released, the GBP makes gains against the US Dollar and the Euro. As the report release time approaches, traders become more nervous and volatility increases as traders get in and out of positions before the report.
Playing the Reaction
When the scheduled time arrives, imagine the report shows a surprise. Retail Sales for the month are now showing a drop of 1 and a drop of 2 percent for the year. Once this occurs, what would you expect the market reaction to be? Does the GBP remain neutral? Does the GBP rally? Or, is the GBP sold off?
“In a scenario like this, it would not be a surprise to see the GBP sell-off after a market event where data dissapoints expectations,” said Ann Gorenkova, currency analyst at NordFX Company . There are two reasons for this. First, on a basic level, the data report tells us that the British economy is slowing and that national growth could remain weak in the near future. Consumers are buying fewer items and this lack of economic activity is never viewed as encouraging.
The second reason that the GBP is likely to weaken because the market is getting a negative surprise. If you remember, the majority of bank and market analysts had expected a positive number for the British Retail Sales report. Because of this, many aggressive traders chose to buy the GBP in anticipation of a strong performance. When the reality was found to contradict this, those traders were forced to sell their positions in the GBP and this helped to drive prices lower. Hypothetical activities like those should be considered when looking to base trades on market news events.