So, the report contributes a lot of perspective when considering positions on a long term horizon. This is why currency investors will always review the results of the U.S. trade balance report simultaneously when looking at important data points like consumer prices, gross domestic product and Federal Reserve rate announcements. (For more on how the imports and exports effect the economy, read Understanding The Current Account In The Balance Of Payments.)
And, then there's the short term.
Short term investors will consider the trade balance report as it relates to market sentiment. This is similar to the long term trader as the report acts as a simple component. But, it's different in that the investors will use the report as a reason to either buy or sell positions in the currency. Long term investors tend to trim their larger currency exposure, rather than completely buying or selling their positions.
How It Works
To clarify, let's take a look at some examples in the EUR/USD exchange rate.
With Europe's financial crisis surfacing and concerns over a Greek default mounting, the EUR/USD had come under selling pressure in the beginning of June 2011. Short term traders saw the pessimism surrounding the EUR/USD exchange rate and had already sold short the EUR while buying the U.S. dollar in the two sessions preceding the U.S. trade report release. If the U.S. trade balance was positive, this would be another great opportunity to sell the EUR/USD pair.
On June 9, the U.S. trade balance report was better than expected. The figure beat estimates, with the deficit shrinking to just under $44 billion. Now, although not positive, the contraction meant that the overall trade deficit was improving – a dollar positive.
|Figure 1 – Traders referring to the U.S. trade balance report shorted the 1.4630 resistance level|
Initiating short EURUSD positions at resistance of 1.4630 (Figure 1), and corresponding stops 50 pips above, traders were able to capture an intraday gain of about 150 pips (a 3:1 risk/reward ratio). The trade becomes even more profitable in the medium term as the spot exchange continues to decline to 1.4350 before testing major support.
Fast forward to July 2011, and a different opportunity emerges.
This time, on July 12, 2011, the market sentiment changed a bit. Although traders and investors were still concerned about a European financial crisis, the U.S. debt ceiling debate had begun to emerge. So, any U.S. dollar negative news would add to already rising concerns of a U.S. credit downgrade.
Short-term traders referring to technical analysis could already see that the EUR/USD currency decline seemed to be stalling. Confirmation of this signal would be a break of the descending trendline (1.4320-1.4044) in the 15-minute time frame (Figure 2). A penetration of this resistance level would indicate that momentum had shifted and that there was upside potential in the pair.
|Figure 2 – Currency traders initiated buy positions at the retest of a broken trendline barrier|
And, that's just what happened. Hours before the release, the EUR/USD pair broke through the trendline resistance - signaling a move higher. Short term traders watching this level placed long or buy positions on support of 1.3950 with corresponding stops of 50 pips placed below.
Intraday traders long on this position would have profited nicely as the EUR/USD topped out at 1.4052 that afternoon - giving traders a 100 pip gain (a 2:1 risk/reward ratio). Medium-term traders who held on would have seen the EUR/USD climb to as high as 1.4100.
The Bottom Line
Given these examples, it's easy to see that analyzing and applying the trade balance report is necessary to currency portfolio positioning these days. Without it, the FX investor will be missing out on underlying signs of a trend – both in the short and long term. But, those that are able to capitalize on this rather obscure report will benefit immensely from it.
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