Trading the Nonfarm Payroll Report

The Non-Farm Payroll (NFP) report is a key economic indicator for the United States. It is intended to represent the total number of paid workers in the U.S. minus farm employees, government employees, private household employees, and employees of nonprofit organizations.

The non-farm payroll report consistently causes one of the largest rate movements of any news announcement in the forex market. As a result, many analysts, traders, funds, investors, and speculators anticipate the NFP number and the impact it will have on forex. With so many different parties watching this report and interpreting it, even when the number comes in line with estimates, it can cause large rate swings.

The NFP report is typically released on the first Friday of each month, so it shows the total monthly increase or decrease in paid U.S. workers across most businesses. Increasing numbers may show economic expansion but may also give investors reason to be concerned about inflation, while decreasing numbers suggest broader economic concern.

Analyzing the Non-Farm Report Numbers

Like any other piece of economic data, there are three ways to analyze the U.S. non-farm payroll number:

• A higher payroll figure is generally good for the U.S. economy. This is because more job additions contribute to healthier and more robust economic growth. Consumers who have both money and a job tend to spend more, leading to growth. As a result, foreign exchange traders and investors look for a positive addition of at least 100,000 jobs per month. Any release above that figure will help to fuel U.S. dollar gains. An above-consensus estimate release will have the same effect.
• An expected change in payroll figure causes a mixed reaction in the currency markets. Forex investors witnessing an expected change in the NFP report will turn to other sub-components and items to gain some sort of direction or insight. This includes the unemployment rate and manufacturing payroll sub-component. So, if the unemployment rate drops or manufacturing payrolls rise, currency traders will side with a stronger dollar, a positive for the U.S. economy. But, should the unemployment rate increase, manufacturing jobs decline, investors will drop the U.S. dollar for other currencies.
• A lower payroll figure is detrimental for the U.S. economy. Like any other economic report, a lower employment picture is negative for the world’s largest economy and the greenback. Should the NFP report show a decline below 100,000 jobs (or a less-than-estimated print), it’s a good sign the U.S. economy isn’t growing. As a result, Forex traders will favor higher-yielding currencies against the U.S. dollar.

Trading News Releases

Trading news releases can be very profitable, but it is not for the faint of the heart. This is because speculating on the direction of a given currency pair upon the release can be very dangerous. Fortunately, it is possible to wait for the wild rate swings to subside. Then traders can attempt to capitalize on the real market move after the speculators have been wiped out or have taken profits or losses. The purpose of this is to attempt to capture rational movement after the announcement, instead of the irrational volatility pervading the first few minutes after an announcement.

The release of the NFP generally occurs on the first Friday of every month at 8:30 a.m. EST. This news release creates a favorable environment for active traders because it provides a near guarantee of a tradable move following the announcement. As with all aspects of trading, whether we make money on it is not assured. Approaching the trade from a logical standpoint, based on how the market is reacting, can provide us with more consistent results than simply anticipating the directional movement the event will cause.

The NFP Trading Strategy

The NFP report generally affects all major currency pairs, but one of the favorites among traders is the GBP/USD. Because the forex market is open 24 hours a day, all traders have the ability to trade the news event.

The logic behind the strategy is to wait for the market to digest the information’s significance. After the initial swings have occurred, and after market participants have had a bit of time to reflect on what the number means, they will enter a trade in the direction of the dominating momentum. They wait for a signal indicating the market may have chosen a direction to take rates. This avoids getting in too early and decreases the probability of being whipsawed out of the market before it has chosen a direction.

The Rules

The strategy can be traded off of five- or 15-minute charts. For the rules and examples below, a 15-minute chart will be used, although the same rules apply to a five-minute chart. Signals may appear in different timeframes, so stick with one or the other.

1. Nothing is done during the first bar after the NFP report (8:30 to 8:45 a.m. in the case of the 15-minute chart).
2. The bar created at 8:30 to 8:45 will be wide-ranging. Traders wait for an inside bar to occur after this initial bar (it does not need to be the very next bar). In other words, they are waiting for the most recent bar’s range to be completely inside the previous bar’s range.
3. This inside bar’s high and low rate sets up our potential trade triggers. When a subsequent bar closes above or below the inside bar, market participants take a trade in the direction of the breakout. They can also enter a trade as soon as the bar moves past the high or low without waiting for the bar to close. Whichever method you choose, stick to it.
4. Place a 30-pip stop on the trade you entered.
5. Make up to a maximum of two trades. If both get stopped out, don’t re-enter. The inside bar’s high and low are used again for a second trade if needed.
6. The target is a time target. Generally, most of the move occurs within four hours of the release of the report. Thus, traders exit four hours after their entry time. A trailing stop is an alternative if traders wish to stay in the trade.

Example

Looking at the chart above, the vertical line marks the 8:30 a.m. EST (1:30 p.m. GMT) release of the NFP report. As you can see from the chart, there are three bars, or 45 minutes, of back-and-forth action following the release. During this time, traders do not trade until they see an inside bar. The inside bar has a square around it on the chart. This bar’s price range is fully contained by the previous bar. Traders will enter when a bar closes higher or lower than the inside bar. The next bar’s close is circled, as that is their entry; it closed above the inside bar’s high. Their stop is 30 pips below the entry price, which is marked by a solid black horizontal bar.

Because their entry occurred at approximately at 9:45 a.m. EST (2:45 p.m. GMT), they will close out their position four hours later. By entering the trade at 1.4670 and exiting four hours later at 1.4820, 150 pips were captured while risking only 30 pips. However, it should be noted not every trade will be this profitable.

Strategy Pitfalls

While this strategy can be very profitable, it does have some pitfalls to be aware of. For one, the market may move in one direction aggressively and thus may be beginning to fade by the time we get an inside bar signal. In other words, if a strong move occurs prior to the inside bar, it is possible a move could exhaust itself before we get a signal. It is also important to note in high volatility times, even after waiting for a pattern setup, rates can reverse quickly. This is why it is very important to have a stop in place.

The Bottom Line

The logic behind this strategy of trading the NFP report is based on waiting for a small consolidation, the inside bar, after the initial volatility of the report has subsided and the market is choosing which direction it will go. By controlling risk with a moderate stop, we are poised to make a potentially large profit from a huge move that almost always occurs each time the NFP is released.