Kathleen Brooks on Forex

A simple approach to trading foreign exchange using fundamental and technical analysis

Kathleen Brooks

• Publisher: Harriman House
• Year: 2013
• ISBN:
  9780857193117
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Inversiones y valores

A simple approach to successful forex tradingMany foreign exchange traders use either fundamental analysis or technical analysis and they're often considered to be mutually exclusive approaches. But FX does not have to be traded that way - fusing the two types of analysis will improve your research and, more importantly, your trading results.This is how Kathleen Brooks trades foreign exchange and she has found it to be extremely successful. In Kathleen Brooks on Forex she reveals the secrets of this approach, demonstrating the indicators she uses, and showing through detailed examples how she plans and executes profitable trades.At the heart of Kathleen's trading philosophy is the principle that fundamental factors - politics, economics and societal changes - cause currency prices to move in the medium to long term (and sometimes in the strangest ways), but throughout the day the price movements are based upon technical factors. Building a trading plan around the two sets of factors works for her and by reading about how she does her pre-trade market analysis (the homework), forms a trading plan and puts the plan into action, you will see how to apply this principle in practice in your own trading.The book is divided into four sections:- Part A - using fundamental indicators to gain an impression of the market- Part B - using technical indicators to refine your trading plan- Part C - fusing fundamental and technical analysis to select trades- Part D - revealing Kathleen's risk management techniquesKathleen's description of her method, and ideas on how you can use it too, will appeal to anyone who wants to learn more about how to trade foreign exchange as well as those already in the market looking for a fresh approach. Blissfully free of rhetoric, written in an accessible personal style and punctuated with anecdotes from Kathleen's unique career in the markets, this is a new and refreshing look at foreign exchange.

PART A – Fundamental Analysis

Introduction

The term fundamental analysis is very widely used, but what does it actually mean? The definition of fundamental includes:

The foundation or base, forming an essential component of a system and something of great importance.

There are also musical, religious and scientific definitions of fundamental but its definition in relation to the FX market is quite specific – it is the study of the underlying factors that drive a currency’s price. In the FX market these underlying factors include the economy, central banks and politics.

We use fundamental analysis in the forex market to help us answer a few basic questions related to these factors, for example:

1. Which economies in the world are growing?
2. Is the growth healthy and sustainable?
3. What are governments and central banks doing to manage their economies?
4. What is the political situation?

The forex trader making use of fundamental analysis takes the answers to these questions and applies them to the decisions they make when placing a trade in the forex market. To explain how this is done I will work through some real-life examples of how to trade using fundamental analysis later in the book.

Trading using economic data

The way to get the information needed for fundamental analysis is to look at the official economic data releases. For most of the world’s major economies, economic data is released regularly and it gives a glimpse of the overall economy and how fast it is growing. The key thing for me is that economic growth means future prosperity, which should then equate to a strengthening currency. Traders seek out growth because that is usually where the best opportunities lie to jump on an uptrend. Alternatively, economic data showing weakness in a country’s economy has the effect of weakening the currency.

The markets have a tendency to price in future growth and prosperity. The forex market, like the stock market, is thought to price in future growth expectations up to six months in advance. Hence markets don’t wait for the GDP release that comes out every three months before deciding on the direction of a currency; they react to the incremental flow of data from economic indicators throughout the month in anticipation of what that means for GDP and the overall health of the economy.

In addition to GDP the other indicators include inflation data, retail sales, industrial and manufacturing data, and data on consumer confidence. These are a timely update on the state of the economy and the occasions of their release can be major market-moving events.

In fact, there are thousands of economic indicators and it could make you dizzy if you tried to analyse them all and determine what they mean for growth. As an example of some of the kookier ways of measuring economic growth, some people may look at the hog market to try and detect Chinese consumption of pork and use that to deduce the strength of the Chinese economy. Others have been known to search out demand for a certain chemical found in paint and then try to apply that to demand for housing in the US.

Thankfully there are more accessible ways to understand what is going on from an economic perspective and for some people it is most effective to narrow the list down to a few key indicators. It is also possible to prioritise the indicators so that you can organise your analysis and know which to pay most attention to. I will now move on to introduce the economic indicators that I have found to be of most use in my own fundamental analysis. Before I do, a couple of words on finding economic data.

Use of an economic calendar

It is important to know when economic data is released and the easiest way to get this information is by using a calendar. You can get reliable up-to-date calendars on economic news websites like Bloomberg (www.bloomberg.com/markets/economic-calendar), some blogs have them – like Forex Factory (www.forexfactory.com), and the financial press often prints economic calendars at the start of each week. Also, ask your FX broker as they may provide you with a free calendar. Some even contain widgets that let you place orders or trade directly from the calendar.

Consensus

The key thing for traders to remember is that the actual data that comes out is only relevant based on whether it hits, misses or exceeds consensus. Consensus is an important word for the markets. Usually economic data calendars include the market’s expectation of the data release. The expected number is the mean of estimates from a number of economists who have been polled prior to the event and asked to give their views on what the number will be. Reuters and Bloomberg are some of the most popular data providers that measure the street’s expectations prior to major data releases.

As a general rule, a data miss (the figures released are worse than the forecasts) can be currency negative, a number around expectations usually has a negligible effect, and if the reading exceeds expectations this tends to be currency positive.

Economic indicators

In this section I introduce the four major fundamental indicators that I use to assess the forex market. These are:

1. Labour market surveys
2. Purchasing Managers Index (PMI) surveys and Institute for Supply Management (ISM) surveys
3. Inflation data
4. Quarterly GDP

For each I explain what the indicator is, when it is released, why it is significant and give examples of how it can be used.

1. Labour market surveys

What is it?

Without a shadow of a doubt the most important economic statistic for me is the US nonfarm payrolls (NFP) report. It is published by The Bureau of Labor Statistics and measures the number of jobs created in the nonfarm sector of the US economy each month.

When is NFP data released?

The first Friday of every month.

Why is NFP data significant?

American labour market statistics are important because they give an idea about the confidence of American businesses for the future. If a company believes growth will be strong for their product or service going forward they will hire more workers to meet the expected increase in demand. If they think demand is going to contract they will reduce their employee numbers.

Hiring by firms also has an impact on consumer confidence. If people have stable jobs then consumer confidence should be high and they will spend money, whereas if people are losing their jobs the first thing they usually do is cut their spending. Since consumption makes up 70% of the US economy (a level that is far from unique in the West) and jobs are a key component of whether or not consumers are spending, you can understand why the market is so obsessed by this indicator.

NFP data has an enormous impact on all financial markets. Currencies can move more than they customarily would on any normal day and it’s not unusual for the major dollar crosses to move a couple of hundred pips in either direction. Stock markets across the globe are also on high alert. Due to the huge amount of volatility that this data can generate, many traders in Asia and Australia stay awake or get up in the middle of the night to place a trade.

FX market example

Lots of people trade before, during and after nonfarm payrolls, and for some of the major ...