MT5_5. Market News Trading Technique

Lesson 4: Market News Trading Technique

In the equities market, fundamental analysis looks to measure a company's true
value and to base investments upon this type of calculation. To some extent, the
same is done in the retail forex market, where forex fundamental traders evaluate
currencies, and their countries, like companies and use economic announcements to
gain an idea of the currency's true value.

All of the news reports, economic data and political events that come out about a
country are similar to news that comes out about a stock in that it is used by
investors to gain an idea of value. This value changes over time due to many factors,
including economic growth and financial strength. Fundamental traders look at all of
this information to evaluate a country's currency.

Given that there are practically unlimited forex fundamentals trading strategies based
on fundamental data, one could write a book on this subject. To give you a better
idea of a tangible trading opportunity, let's go over one of the most well-known
situations, the forex carry trade.

The currency carry trade is a strategy in which a trader sells a currency that is
offering lower interest rates and purchases a currency that offers a higher interest
rate. In other words, you borrow at a low rate, and then lend at a higher rate. The
trader using the strategy captures the difference between the two rates. When highly
leveraging the trade, even a small difference between two rates can make the trade
highly profitable. Along with capturing the rate difference, investors also will often
see the value of the higher currency rise as money flows into the higher-yielding
currency, which bids up its value.

Real-life examples of a yen carry trade can be found starting in 1999, when Japan
decreased its interest rates to almost zero. Investors would capitalize upon these
lower interest rates and borrow a large sum of Japanese yen. The borrowed yen is
then converted into U.S. dollars, which are used to buy U.S. Treasury bonds with
yields and coupons at around 4.5-5%. Since the Japanese interest rate was
essentially zero, the investor would be paying next to nothing to borrow the
Japanese yen and earn almost all the yield on his or her U.S. Treasury bonds. But
with leverage, you can greatly increase the return.

For example, 10 times leverage would create a return of 30% on a 3% yield. If you
have $1,000 in your account and have access to 10 times leverage, you will control
$10,000. If you implement the currency carry trade from the example above, you will
earn 3% per year. At the end of the year, your $10,000 investment would equal
$10,300, or a $300 gain. Because you only invested $1,000 of your own money, your
real return would be 30%.
However, this strategy only works if the currency pair's value remains unchanged or
appreciates. Therefore, most forex carry traders look not only to earn the interest
rate differential, but also capital appreciation. While we've greatly simplified this

transaction, the key thing to remember here is that a small difference in interest rates
can result in huge gains when leverage is applied. Most currency brokers require a
minimum margin to earn interest for carry trades.

You may have noticed that from the very practical standpoint of an average Forex
trader, it is news reports that produce movements on the markets.
Economic data may hint towards shifts in the economic situation of the respective
country.

Let’s go over some key news events.
Interest rates are a major fundamental Forex analysis indicator. There are many
kinds of interest rates, we’ll talk about the nominal or base interest rates set by
central banks.
Central banks create money. That money is then borrowed by private banks. The
percentage or the principle that private banks pay central banks for borrowing
currencies is called a base or a nominal interest rate. Whenever you hear the phrase
'interest rates', people are usually referring to the aforementioned concept.

Manipulating interest rates - a big part of the national monetary or fiscal policy - is
one of the primary functions of the central banks. This is because interest rates are a
great leveller of the economy. Interest rates, perhaps stronger than any other factor,
influence currency values. They can impact on inflation, investment, trade,
production and unemployment.

From a Forex fundamental analysis standpoint, the best place to start looking for
trading opportunities is in the changing interest rates.

Another term one should be on the lookout for is inflation.
News releases on inflation report on the fluctuations in the cost of goods over a
period of time. Note that every economy has a level of what it considers 'healthy
inflation'. Over a long period of time, as the economy grows so should the amount of
money in circulation, which is the definition of inflation. The trick is for governments
and central banks to balance themselves at that self-set level.

Finally, there’s the GDP.
Gross domestic product is the measurement of all goods and services a country
generates within a given period. GDP is believed to be the best overall economic
indicator of the health of the economy. This can seem odd, considering GDP is
basically a measurement of supply of goods and services, yet it has nothing to do
with the demand for these goods and services. The general idea is that it takes a
knowledge of both supply and demand to make reasonable estimations. It would be
unwise to believe that GDP reflects both sides of the market. Therefore, an increase
in GDP without a corresponding increase in gross domestic product demand or
affordability, are the very opposite of a healthy economy from a fundamental Forex
analysis perspective.

Interest rates, inflation and GDP are the three main economic indicators employed
by Forex fundamental analysis. They are unmatched by the amount the of economic
impact they can generate compared to other factors such as retail sales, capital flow,
traded balance as well as bond prices and numerous additional macroeconomic and
geopolitical factors. Moreover, economic indicators are not only measured against
each other through time, but some of them also correlate cross-discipline and
cross-borders.

It is important to understand that there is a lot of economic data released that has a
significant impact on the Forex market. Whether you want to or not, you need to
learn how to make Forex fundamental analysis a part of your trading strategy to
predict market