Tips on How to trade the Non-Farm Payrolls

Introduction

This article discusses trading FX based on the Non-Farm Payrolls. It is a given that there is an element of risk in trading FX. However, an understanding of some basic concepts about major economic indicators, such as the Non-Farm Payrolls report, can minimize some of that risk.

Background

Financial markets in the US, Europe and around the world react, often sharply, to global economic events. These events can also have a significant impact on the currency markets, so it is important for currency traders to monitor the release of major economic indicators, such as US Non-Farm Payrolls (NFP). This indicator is also referred to as US Non-Farm Employment Change.

NonFarm Payroll

Definition: measures the number of jobs added or lost in the US economy over the last month.

Publication: released usually on the first Friday of each month, at 8:30 EST. It is published by the US Department of Labor.

Significance: considered the most important employment indicator. It provides a look at the health of the US economy in general, and the labor market in particular.

How NFP affects the US Dollar

As one of the most important economic indicators, the NFP release can have a major impact on the forex markets and can affect the direction of the US dollar. This means that traders should always treat the NFP report as market-moving data.

A NFP which is stronger than the estimate (also known as the forecast) indicates that the labor market is stronger than what the markets expected, and the dollar often rises as a result. Why? Let's use a stock market analogy to answer this question. Just like a company's stock often rises after the company releases a strong financial report, so to the US dollar can be thought of as the "stock of the US economy". Thus, when the US releases a strong economic report, the "stock" (US dollar) often rises against other currencies (such as the euro, pound or yen) as a result.

Conversely, a weak NFP report indicates that the labor market is weaker than what the markets anticipated, and a weak reading can push the dollar lower against other currencies.

TIP: Mark your economic calendar so that you can monitor the release time of NFP.

The chart above, taken from the FXStreet Economic Calendar, provides the estimates and actual readings for the June 2015 and May 2015 NFP reports.

Each report covers the employment change measured in the previous month. The June report, released on June 5, covers the employment change measured in May. Similarly, the May report, released on May 8, covers the employment change measured in April.

The chart shows the following:

June reading: actual release: 280 thousand
                               estimate: 222 thousand

May reading: actual release: 223 thousand
                               estimate: 224 thousand

D. Effect of NFP release on the markets

When trading based on economic events, it's always a good idea to be well-versed with that particular sector of the economy. So, for trading based on the NFP, a trader should have a solid understanding of employment conditions in the US. The more knowledge you have, the more confident you will feel trading the NFP. Don't accept the market estimates as written in stone; they are often well off the mark. Ask yourself if you think the NFP will improve or lose ground in the next release. If, for example, you feel that the NFP may move higher, then there's a strong chance that the US dollar will move higher following the release (we'll explain why shortly).

TIP: Keep current on financial news, especially on the US labor market and employment conditions. This will help you trade the NFP. 

Trading before release of NFP

The period immediately before the NFP release is when market uncertainty is at its highest “ will the reading move higher or lower compared to last month? This uncertainty can lead to volatility in the forex markets, as traders and investors anxiously await the release. Trading during this time carries additional risk, as the markets do not have any solid data to work with prior to the release. Nonetheless, the volatility often seen prior to a major event does present trading opportunities.
 

Trading after release of NFP

We noted earlier that the NFP is a major economic indicator, and that there is a strong likelihood that the currency markets will move after the NFP is released. Will the US dollar move up or down? That of course, is the million dollar question which nobody can predict, but we can use a general rule to help us make an educated guess:


NFP is higher than the estimate >> dollar will likely move higher

NFP is lower than the estimate >> dollar will likely move lower


However, this rule is not absolute, and another factor that we need to keep in mind is the previous release (one month earlier). If NFP showed a higher gain in the current reading compared to the previous reading, but fell short of the estimate, the dollar could still rise because the indicator improved in actual numbers, despite falling short of the estimate.
There is of course, the possibility that the markets will not show much movement at all following a major release like NFP. This could happen if the actual reading is close to the estimate. However, if the reading is significantly higher or lower than the estimate, there is a strong chance that the dollar will respond with some movement.
 

Duration of NFP release on markets

Economic indicators like NFP are considered short-term market movers. This means that the dollar often reacts immediately after the indicator is released, but in some cases, the NFP reading can affect the markets for up to 2 or 3 days. This means that market volatility is most likely right after the release of NFP, but the markets can experience volatility well after the actual release time.
 

TIP: If there is volatility after the NFP release, it is likely to be at its strongest in the first few hours after the release.