Friday, September 4, 2009

How to Trade this Friday’s US Non Farms Payrolls Report

There are two popular ways to trade non-farm payrolls.

• The first is to position before the release based upon your view of non-farm payrolls, and if right, be ready to exit on the first sign of reversal. If wrong, get out quickly using a tight sell stop and watch to get back in if the direction changes after the first hour or so.

• The second is to wait for the knee jerk reaction to settle and then get play the bounce that often occurs after the first hour. This move is often the larger of the two.

Interpreting the Results

The key levels to watch for the non-farm payrolls report are around the -200k and -400k band. A drop near -200k or less, is likely to be very positive for risk appetite which means a strong rally in the dollar against the Yen but may mean weakness against higher yielding currencies such as the euro and Australian dollar. If the payrolls decline is around 400k or more, traders could expect a wave of risk aversion that could drive the dollar lower against the Japanese Yen but higher against the riskier currencies. Anything in between should elicit only a modest reaction in the direction of the surprise.

Note however, that the USD has a real chance of rising in either case. If news disappoints, it could rise in its usual role as a safe haven. When NFP has been good, however, the USD has ALSO gone up in one of the rare cases of its trading on US economic fundamentals. So your planning should have a bias to at least a brief USD jump, perhaps a longer one.

Why these two strategies?

Lien The reasoning behind these strategies, first widely publicized by Kathy Lien of fx360, is that non farms payrolls often cause massive volatility in the first 30 minutes following the release. Nearly every time that the number has been released this year, we see a spike in both directions. By placing a position before payrolls, if you are right, hopefully your targets will be hit immediately after the number and before the reversal. So you need to avoid greed, set a reasonable target for a sell order or, if you plan on actively watching the move, be ready get out at the first signs of reversal.

Which to Choose?

However we suggest that the better strategy is to wait until the volatility settles and then get in. Every month, we have seen that it pays to wait because the trend that manifests the hour after payrolls tends to be the one that last for the rest of the trading day, which can typically yield more than 100 additional pips. There is nothing wrong with trying both, that is, taking a small position ahead of the report, and then committing your full position after the first hour.

Of course, this month is slightly different from others because it is a long weekend and therefore volume could drop off by noontime in NY if not earlier. That potential lack of liquidity means greater potential volatility. Therefore traders need to be vigilant about their stops and limits.

Our Prediction

More likely to be positive, given the following leading indicators:

  • The employment component of service sector ISM, which was released this morning rose from 41.5 to 43.5 which confirms that in the service sector, the pace of job losses is decreasing.
  • Yesterday, payroll provider ADP reported the fewest private sector job losses since September 2008.
  • Challenger Gray & Christmas reported the largest decline in layoffs since February 2008.
  • Online job board reported the sharpest monthly gain in their Employment Index since August 2005. This indicates that after 3 consecutive months of fewer ads, companies are hiring again.

Points of concern:

Jobless claims were higher last month. Therefore most likely, we will only see a modest improvement in non-farm payrolls and since the U.S. economy is still experiencing net job loss, the unemployment rate should rise from 9.4 to 9.5 percent.

Risk assets remain near highs. Thus good news can be a catalyst to profit taking, especially on a low liquidity pre-vacation Friday

What to Do & Conclusion

If the report is positive:

Traders: go long risk assets like stocks, stock indexes, crude oil and other commodities (careful with gold/silver, they’re at multi-month resistance) and risk currencies [AUD,NZD, CAD, EUR, GBP in order of risk appetite appeal]. Again, the USD has risen before on positive NFP news. If so, it might well gain against the EUR, AUD, and other higher risk appetite currencies.

Investors: May wish to consider adding to longer term stock positions, especially those we’ve recommended over the past 8 months.

Disclosure & Disclaimer: The opinions herein are not necessarily those of AVA FX. The author has positions in the above mentioned instruments.

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