Use GDP in your forex trading

Economic releases are essential for the fundamental trader, and can also help the technical trader when judging how long a trend is likely to last.

Gross domestic product, or GDP, is one of the most important releases, covering an economy’s consumption, investment, government spending and investment, and exports. The sum of these numbers is the GDP. 

As GDP takes a number of macroeconomic factors into consideration, it serves as evidence of growth in a productive economy, or shrinkage in a weakening one. Consequently, forex traders often go long on the currencies of countries with higher GDPs in the belief that interest rates will also rise. If an economy is growing, the benefits should trickle down to the consumer who will be more likely to spend, resulting in higher prices and higher interest rates as central banks try to ward off inflation.

Expectations and their affect on the forex market

GDP figures are released in three versions, advanced, preliminary and final. Currency professionals will use the advanced version when trading; however, they will then compare this with the preliminary and final ones as they are released. There are three possibilities when the final version is released – the GDP figure will be higher than expected, lower than expected or as expected.

If the advanced release predicted GDP growth of 1.5% and the final release announced 4% GDP growth, the underlying currency is likely to strengthen in relation to other currencies, as forex traders think it is a better investment. Typically, the higher the GDP figure, the sharper the currency’s incline.

An expected figure generally requires some more comparison. A trader should compare the current figure to that of the previous quarter or the previous year to evaluate the situation. If GDP growth is positive, but not as high as the previous quarter, this is likely to be negative for the currency. Likewise, if GDP growth is higher than the previous quarter or year, traders are likely to invest.

On the other hand, if an advanced release predicts 3.5% GDP growth and the final version only states 2% GDP growth, that economy’s currency is likely to drop as traders sell-off, following the lower reading. A lower GDP figure would warn of an economic contraction and lower interest rates, lowering the value of assets denominated in that currency.

Example

UK GDP for the second quarter in 2011 only increased by 0.2%, following a 0.5% increase in the first quarter. Although special events associated with the quarter, such as the royal wedding and the Japanese tsunami, may have had an impact, growth was lower than expected.

If we look at the GBP/EUR chart approaching the July 26 preliminary GDP release, the pound hits a two-week low against the euro ahead of economic data. The figures, released at 8:30am, were expected to show faltering economic recovery, with GDP growing just 0.2% in the second quarter. The release did, in fact, release the expected figures.

As the figures were to be expected, and the eurozone also hasn’t been performing well recently, this could be a good opportunity to go long. This is backed up by the chart over the following days – having hit a low of 1.2566 against the euro, the forex pair started to climb following the expected release, trading within the 1.138 and 1.144 range until the August 1 US debt ceiling announcement. 

 GBP/EUR

If the release had been worse than expected, the pair may have tested its early-July low of 1.10089. And, if the release had been better, traders could expect a steeper rise, though there would always have been further volatility surrounding the US debt ceiling agreement.

Conclusion

The GDP reports of any major currency will always be an important fundamental to consider when it comes to trading forex. Releases that vary from expectations can be great opportunities for traders to cash in on large currency movements.