Sentiment in the Forex Market: Indicators and Strategies to Profit from Crowd Behavior and Market Extremes

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c02 JWBK195-Saettele May 31, 2008 11:19 Printer: Yet to come

12 SENTIMENT IN THE FOREX MARKET

All of the charts shown here are monthly (since the indicators that

we are looking at are released once a month) and the correlations are

3-year (36-month) correlations. The economic indicators that are assumed

to be of utmost importance when it comes to valuation of the U.S. dol-

lar are the nonfarm payrolls report (Employment Situation), the Treasury

International Capital number (investment flows), the U.S. trade balance,

gross domestic product, and the Consumer and Producer Price indexes. I

have included rather detailed descriptions of the economic indicators as

well. If you are going to enter into a debate with someone who contends

that economic indicators are the secret to trading success, then it is wise

to know what you are arguing about. You will also see that some of the

ways in which the economic numbers are calculated are suspect, to say the

least.

NONFARM PAYROLLS

On the first Friday of the month, the Employment Situation report is

released by the Bureau of Labor Statistics (BLS). To be honest, the release

of the indicator can, and often does, lead to one of the more exciting

days to be in the market. It makes sense that analysts and traders would

assume that employment is critical to currency valuation. A country that

cannot employ its citizens is certainly facing economic problems. In the

United States, consumer spending accounts for roughly 70 percent of gross

domestic product (GDP). A loss of jobs will most likely lead to a decrease

in discretionary income, which leads to a decline in consumer spending,

which leads to a decline in GDP (we will look at GDP later). It seems

logical that the release of the Employment Situation report would be a

main determinant in the price of the Dollar Index (DXY), and by extension

the EURUSD, GBPUSD, USDJPY, and so forth. However, remember that

the market is far from logical. Believing that the market will move based

on what should be logical is the kind of thinking that gets us in trouble in

trading.

The big number within the Employment Situation, and the number

that we will examine, is the change in nonfarm payrolls. The calculation

of the employment statistics includes people age 16 and older. The BLS

defines employed people as those who have worked and been paid for

their work by someone else or by themselves. Those who are on leave

from a job, paid or unpaid, are also considered employed. Examples in-

clude maternity or paternity leave, illness, or vacation. Unemployed peo-

ple are those who have either quit or been fired. There are several types of