How to Trade the Nonfarm Payroll Report

The nonfarm payroll report impacts forex and day trading based on expected or actual results. Traders generally view an addition of more than 100,000 as an indicator of a growing economy and an addition of fewer than 100,000 jobs as an indicator of a declining economy. They base trading decisions on the report.

About the Nonfarm Payroll Report

The nonfarm payroll (NFP) report is a key economic indicator for the United States. It represents the total number of paid workers in the U.S., excluding those employed by farms, the federal government, private households, and nonprofit organizations.

The NFP report is typically released on the first Friday of each month. It provides 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; decreasing numbers suggest a broader economic concern.

The report consistently causes one of the most significant rate movements of any news announcement in the foreign exchange (forex) market. As a result, many analysts, traders, investors, funds, and speculators anticipate the NFP number and its impact on forex.

Analyzing the Nonfarm Report Numbers

There are three ways to analyze the U.S. nonfarm payroll number. Some wait for the report to be released and base their actions on whether the results are higher or lower than the previous month's figures. Others might base their decisions on expected figures before the report is released.

Higher

A higher payroll figure is generally good for the U.S. economy, citing more job additions and robust economic growth. Forex traders and investors look for a positive addition of at least 100,000 jobs per month. Any release above that figure or the estimated consensus will help to fuel U.S. dollar gains.

Lower

A lower employment picture is viewed as an adverse event for the world’s largest economy and its currency. If the NFP report shows fewer than 100,000 jobs were added in the last month, forex traders view the U.S. economy as stagnant and will favor higher-yielding currencies against the U.S. dollar.

Expected

An expected change in payroll figures causes a mixed reaction in the currency markets. Forex investors anticipating a change in the NFP report will turn to other subcomponents and items, including the unemployment rate and manufacturing payroll subcomponent, to gain some sort of direction or insight.

If the unemployment rate drops or manufacturing payrolls rise, currency traders will side with a stronger dollar, which is a positive for the U.S. economy. If the unemployment rate increases and manufacturing jobs decline, traders will pass on the U.S. dollar for other currencies.

Trading on News Releases

Trading on news releases can be very profitable; however, it can also be volatile. It is possible to wait for wide rate swings to subside when traders can capitalize on the real market move after the early speculators have taken profits or losses.

The release of the NFP report generally occurs on the first Friday of every month at 8:30 a.m. EST. It creates a favorable environment for active traders, providing a near guarantee of a tradable move following the announcement.

As with all aspects of trading, profit is not ensured, so approaching the trade logically, based on how the market is reacting, can provide more consistent results than simply anticipating the directional movement that the event will cause.

What Is the NFP Trading Strategy?

The NFP report generally affects all major currency pairs, but one of the favorites among traders is the British pound/U.S. dollar (GBP/USD). Because the forex market is open 24 hours a day, all traders can trade on the news event.

Once the market has digested the information’s significance and initial swings, traders will enter positions that take the direction of the dominating momentum and wait for a signal, which indicates the market has decided on a direction. This keeps them from jumping in too early and decreases the probability of being whipsawed out of the market before its direction is solidified.

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 time frames, so it helps to remain consistent.

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 from 8:30 to 8:45 a.m. 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 entirely inside the previous bar's range.
3. This inside bar's high and low rates set up your 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. Choose 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 movement occurs within four hours of the report's release. Thus, traders exit four hours after their entry time. A trailing stop is an alternative if traders wish to stay in the trade.

Example of Trading the NFP Report

Looking at the chart below, 8:30 a.m. EST (12:30 p.m. GMT) represents the release of the NFP report. As seen 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 blue horizontal bar.

Because their entry occurred around 9:15 a.m. EST (2:15 p.m. GMT), they will close out their about 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 that not every trade will be this profitable.

Strategy Pitfalls

While this strategy can be very profitable, it has some pitfalls to be aware of. The market may move aggressively in one direction and thus may be beginning to fade by the time an investor gets an inside bar signal. In other words, if a strong move occurs before the inside bar, it is possible that a move could extinguish before a signal.

Rates can reverse quickly during times of high volatility, even after waiting for a pattern to set up. This is why it is essential to have a stop in place.

The Bottom Line

The logic behind the strategy of trading on 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 choosing which direction it will go. By controlling risk with a moderate stop, you are poised to make a potentially large profit from a huge move that almost always occurs each time the NFP report is released.