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Why Is NFP So Important?

The release of the NFP data is hotly anticipated by traders each month because the figure is seen as key to gauging Fed monetary policy and therefore US Dollar strength. As America is the World’s largest economy and the US Dollar is the global reserve currency, the monthly release of the NFP is a focal point of all market participants, from independent speculators right through to investment banks, multinational corporations and central banks.

This level of interest creates two key areas of importance regarding the NFP:

  1. Anticipation
  2. Reaction

The battle for positioning heading into the figure can cause skewed trading conditions in the days leading up to the release. Participants looking to establish positions pre-release can cause unexpected directional flows in a currency pair. For example, if markets are expecting a strong number, we could see people trying to sell EURUSD ahead of the release, expecting USD to strengthen against EUR causing EURUSD to go lower. The volume of this positioning is key. If we see large institutional players positioning, this tends to have a bigger effect on the currency pair than if we are seeing smaller speculative players positioning. The actual size of the positioning itself is also important: if institutional players are positioning with reduced size, it will have less of an impact than if we see them positioning with greater size.

This is where having access to great data feeds comes in so handy, as it’s possible to gauge the level of positioning heading into the figure through analysis of volume tools.

Another situation we can see heading into the figure is large institutional players reducing positions and taking profit heading into a figure release. For example, if institutional players are heavily short EURUSD heading into the figure, and they are expecting a weak NFP result, we typically see them reducing position size heading into the result so that they don’t suffer large negative equity swings on the result (if the result is as they anticipated).

Often the reaction to the figure will only cause a brief, but sometimes large, spike in the price of a currency pair, and so a reduction in position size allows the institutional players to maintain their overall (long-term) position, looking for the market to correct when the news has been digested, the longer term fundamental picture restores balance to the market and they see a resumption of their anticipated directional bias in the currency pair.

This reduction in position size heading into a figure release can itself cause a spike in the price of a currency pair (referred to as a ‘squeeze’) and is often accompanied by speculator action which can extend the moves even more. So for example, we may see EURUSD weaker in the weeks heading into the NFP release, but in the days beforehand as positioning on shorts is reduced, we see price rising. We then see speculators “piggy-backing” the move, which drives the spike even further. For the chart please refer to the video at 3.50. 

Exactly as we discussed above, the chart shows a situation where EURUSD is trending downwards heading into the figure release but suffers a sharp squeeze hours beforehand, only to return to trending downward post release. 

This type of action can create choppy and difficult trading conditions for beginner traders who aren’t aware of what is likely to be going on behind the scenes to cause these moves. This is where having great Order Flow understanding and Order Flow tools can really help to keep you out of trouble in these conditions.

Another situation which is typically seen leading into NFP data release is that as volume in the markets is greatly reduced and players aren’t seen building heavy positions, trading ranges contract greatly and we see very little movement in the days leading up to the NFP result.  These types of contracted ranges can often precede explosive outcomes as volume floods back into the market on reaction to the release.