What is the NFP and How to Trade It

May 17, 2018 17:26

Each first Friday of the month, the U.S. Bureau of Labor Statistics publishes data on nonfarm payroll for the month, which is closely monitored by economists all around the world to track economic trends, identify new directions, and check on the state economy. Nonfarm payroll (NFP) is one of the key economic indicators in the U.S., which shows the total number of paid workers minus farm employees, government employees, and employees of non-profit organisations.

The Importance of the NFP to Traders

As to Forex & CFD traders, this is one of the indicators to look out for. When the reports on employment (number of jobs, employment rate, hourly earnings) exceed expectations, it is nothing but a very significant signal of an economy, which fulfils expectations of investors or, in that case, even surpasses it. When such a situation occurs, a rise of a currency against others should be expected. Nonfarm payrolls have a strong influence on the US dollar, since it reflects 80% of the U.S. economy.

The U.S. is at Full Employment

The topic of the U.S. employment reports and the Forex market is more than relevant, especially with the full U.S. employment at the present. Additionally, US president Donald Trump has mentioned his plans on returning jobs to the United States all along with taxing companies, deciding to leave their manufacturing facilities offshore. Such statements give rise to many questions, for traders especially, e.g., what to expect, how soon it could be done, and whether it could be done at all.

These questions are fair to ask, however, if we look at it from a different perspective, it would strengthen the US dollar against other currencies if more jobs are brought back, and the economy strives. On the other hand, we may see that bringing back some jobs would require the companies to raise the prices, which would diminish the purchasing power of an average American household, thus, potentially, hit down the GDP, all along with the value of its currency.

There is a lot guesswork also as US president hasn't filled his full mandate yet and it is difficult to say how these promises will be brought to life, how long it will take, and whether we will see it happening at all. That's why it is essential for a Forex trader to always follow the news, which is easy in the world of rapidly developing technologies.

How to Trade the NFP

Given the fact that the market is particularly sensitive to the NFP release, it consistently causes large tradable moves in the Forex market. Moreover, since the majority of the market participants are focussing on and interpreting the NFP report, it creates a favourable environment for active traders.

Waiting for the market to price-in the information, rather than speculating on the directional movement, can provide better results. After the initial reaction subsides, the market will reflect what the numbers actually mean for the economy. Entering a trade, following wild swings can help capitalise on the direction of the dominant market momentum. The main purpose behind this is to attempt and capture rational, more sustained movement after the announcement and decrease the probability of being stopped-out by the whipsaw movement lead by the irrational volatility that pervades the first few minutes after an announcement.

The NFP Trading Strategy

Although the NFP report affects most major currency pair, but traders generally prefer trading the most liquid majors, i.e., the EURUSD, GBPUSD, and USDJPY.

We use the strategy for the USDJPY and the time frame used is 1-minute chart. The example is from May 2018 NFP.

After the initial reaction on the 1-minute chart, add Fibonacci retracement levels depending on the initial direction. Traders enter a trade on a retracement towards 61.8%, 78.6%, or 88.6% Fibonacci level. More conservative traders should wait for the price to move past the initial reaction swing high or low before entering a trade. Stop-loss should be placed 5 pips above the swing high for sell positions or 5 pips below the swing low for long trades.

In the following figure, we can see that the initial reaction on the USDJPY was short-selling, just after the NFP release. Then, after a retracement to 61.8%, the price turned down again providing a potential profit of 23 pips.

This is a volatile release, and traders really need to be nimble on their fingertips.

Source: USD/JPY,1-minute chart, Admiral Markets MT5, May 2018

Have in mind that the NFP usually comes packed with two additional reports. The Average Hourly Earnings (wages) that represent the change in the price businesses pay for labour, excluding the farming industry and the unemployment rate, the percentage of the total workforce that is unemployed and actively seeking employment during the previous month.

Both are important and they can turn the price in the opposite direction after the NFP release if the numbers deviate from predicted result. That is why when trading the NFP, traders also need to pay attention to both the average hourly earnings and the unemployment rate. However, the initial reaction on 1-minute time frames usually follow the NFP numbers solely, except if the deviation on other two reports is considerable.

If you have any questions or concerns, don't hesitate to ask me in the comments section below!

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This material does not contain, and should not be construed as containing, investment advice or an investment recommendation or, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not reliable indicator for any current or future performance as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisor to ensure you understand the risks.

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