Economic Growth

The Importance of Economic Growth and Forex Trading

The accepted measure of economic growth of a nation is the Gross Domestic Product, which is defined as the percentage change in the inflation-adjusted value of all goods and services produced in a country. Even though every country releases GDP figures to show the rate at which their economies grew or contracted, the most significant Gross Domestic Product (GDP) figures in forex are released from the United States, Canada, Australia, China, New Zealand and Great Britain. China accounts for 40% of global production, so its GDP data is a market moving event that is keenly watched by all market players.

So when talking of economic growth, we are basically referring to an increase in the GDP. Depending on the country of release, three sets of GDP data may be released to the market. These are:

a)    Advance GDP

b)    Preliminary GDP

c)     Final GDP

The market impact of each of these three GDP data will differ from country to country but generally speaking, the Advance GDP data have the greatest market impact since they are usually the first to hit the markets.

In the UK, three sets of GDP data are released. We have two GDP data from the US, while Canada, Australia, New Zealand and China only have on GDP release of note.

Factors Affecting Economic Growth:

The factors that determine economic growth can be divided into long term and short term growth factors.

Short term, economic growth can be affected positively or negatively by:

a)    An unstable polity in a country. Political instability has great adverse effects on economic growth.

b)    Weather conditions: Drought can severely hit an agriculture-dependent economy.

c)     Unstable commodity prices: This tends to affect countries who are dependent on commodities. The platinum mine strikes in South Africa have severely affected the country’s economy. Countries that operate a near mono-economy also find it hard to grow when commodity prices are unstable.

Long term, economic growth is affected by:

a)    Interest rates: An environment with lower interest rates makes it easy for companies to access credit for expansion, leading to improved wages, increased productivity and better manufacturing indices. Cheaper credit also allows people to have more disposable income, leading to improved consumer spending, all of which grow the economy. Higher interest rates cause the opposite effect.

b)    Infrastructural and human capital development

c)     Advances in technology

d)    Consumer confidence: Confidence in the performance of the economy is a perception of improved outlook. Increased consumer confidence leads to improved consumer spending, which grows the economy.

e)    Asset prices: The rise in prices of assets such as houses will lead to increased revenue for homeowners, giving them the ability to spend more.

f)     Real wages: A fall in real wages is seen when inflation diminished the value of nominal wages.

g)    The local exchange rate: When the currency of an export-oriented economy is devalued, it makes its products cheaper and more of its goods will be exported, leading to increase in revenue for the country. It also promotes consumption of locally-made goods, boosting the domestic manufacturing sector. This is good for economic growth.

Why is the Trade Balance Relevant to Forex Traders?

The GDP is a very important economic indicator which indicates the state of health of a nation’s economy. The Gross Domestic Product (GDP) is not only a high impact news event, but among other economic news of high market impact, it equally ranks at the very top. Moves of up to 150 pips within the first 30 minutes of trading are not unusual. The GDP is the broadest measure of economic activity and the primary gauge of the economy’s health as it encompasses manufacturing, employment, retail sales, consumer spending, etc.

Therefore, a Gross Domestic Product (GDP) figure above the consensus number is seen as good for the local currency, while GDP figures which are lower than consensus is seen as bad for the affected currency.

Trade Scenarios

The trade scenario for a GDP report is very simple.

  • Buy when the actual figure is greater than consensus.
  • Sell when the GDP figure is lower than consensus.

Remember that the greater the deviation, the more the market volatility. Also, remember that for countries where more than one GDP release occurs, the first one is usually the most significant, and that should be the focus of trading for traders.

It is important to study the market to see the state of the global economy and the local economy. This will sometimes indicate the extent to which markets will respond to the GDP data. For instance, in a country which has been in recession, a surprisingly good GDP data which signals economic growth will be hungrily snatched by the market, resulting in a greater response by the currency to the news.

Here is a trade example involving the AUD. The GDP q/q result was released on June 4, 2014:

economic

The expected figure was 0.9%, which was a 0.1% deviation from the previous figure of 0.8%. Two things stand out:

a)    The market was expecting an increase, albeit a muted one.

b)    The actual figure would need to be more than 0.1% deviation from consensus to be considered tradable.

The actual figure came in at 1.1%, which was better than expected and a 0.2% deviation from the consensus, producing a trading opportunity as shown below on the AUDJPY:

economic growth

The response was a 45 pip increase in the value of the AUD against the Yen. The muted response was because the market was expecting an increase. If the result had disappointed to the downside, the expected drop would have been a lot more massive.

Economic growth is good for a country, but it can also be good for the trader when traded whichever way the result goes.

Adam

More About

Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

View Posts - Visit Website

Leave a Reply