What we learned in the previous section is only a small portion. Fundamental analysis is vast and often looks endless. Still, we will cover a few more topics to help you understand the markets even better. Here in this section we will learn about the economic climate and economic calendar and find out how these things impact the binary options market.
Economic Climate Definition: Economic climate is defined by BusinessDictionary.com as “A general characterization of the overall mood of the global economy or of a regional economy, which captures the status of the stock market, the perception of the economy by consumers, and the availability of jobs and credit. Business decisions such as hiring, borrowing, lending, and investment in new initiatives are often strongly influenced by the overall economic climate.”
Economic climate is not easy to understand because you are not dealing with single or isolated events. You are rather dealing with events that affect the whole economy of a country and hence, the overall global economy. For instance, the invention of personal computer had a global effect. Before the introduction of personal computers, everything was done manually. So, the industries used to be labor intensive. But with the boom in computer usage, there was a sudden increase in unemployment rate globally. The immediate effect was that of reduced demand for goods and services because people did not have money. The reduced demands lead to deflation. In other words, prices for good and service fell significantly. However, the world economy recovered from this over time.
Even earlier, in the year 1929 (when most of us weren’t even born) the world faced the problem of Great Depression. The US economy entered recession with a crash in NYSE and then came the mismanagement of the Fed that led to the closing of banks followed by Smoot-Hawley Tariff Act which eventually managed to cut off America from international trades because the foreign nations retaliated with their own tariff policies. As a result, from recession, America went into depression which spread like a wild forest fire and took over the global economy with widespread unemployment and poverty throughout the world.
The idea is that when trading in binary options, you must be concerned about the global economy as a whole. Introduction of new technologies, changes in government policies, changes in fiscal and monetary policies by the governments and financial institutions can actually lead to terrible consequences. The only way to safeguard your investments is to stay abreast with global news and analyze them to understand what can happen next and play safe. Actually, if anything like Great Depression happens again, there will be very little to do. We did face a similar problem. Though it was not as devastating as the Great Depression, it really had some serious and far reaching consequences on the US economy and some other economies in the world. Yes, we are talking about the Great Recession of 2007-2009 which had its effect until 2011. It all started with subprime mortgage crisis because of bad lending practices followed by the US banks. It was because of this Great Recession that Binary Options Trading was introduced in open markets for general people. So, when analyzing the economic climate, you should not just focus on what will follow immediately but also, you must be concerned about what can happen in the long run. Events like Great Depression and Great Recession did not occur in a single day. They were results of years of poor management and poor policies.
So, the question is, “is there an effective way to keep a watch on the economic climate?” Yes, you can partially do that using the economic calendar. So, what is this economic calendar? Let us find out!
Economic Calendar: It is a calendar but not your daily use calendar. It is meant for investors. Investors use this to track the occurrence of the events that can move the market. The calendar gives the release schedule for different economic indicators. The most important events that can be found in an economic calendar are non-farm payroll numbers, interest rate decisions, CPI (Consumer Price Index), GDP (Gross Domestic Product), PMI (Purchasing Managers’ Index) etc. A close look at the economic calendar can give a fair idea of where the economy (regional and global) is going to head in the next few months or perhaps the next fiscal year. It is absolutely not possible to give a detailed explanation of an economic calendar in this course (basic or advanced) however, what we can tell you is that you can easily get hold of the economic calendar through different sources. For instance, you can follow this link http://www.bloomberg.com/markets/economic-calendar/ to see all upcoming major economic events that can affect your trading decisions.
Elements in Economic Calendar
A typical economic calendar will have different elements which are briefly described below:
- News release time: Generally listed in American Eastern Time Zone, there will be some version of economic calendar which will allow traders to convert time to their local time zone.
- Origin Country: The economic news need to originate somewhere. The place of origin of the news is shown on the calendar. Generally abbreviated names of the countries are shown but some economic calendars can use country flags. This column will tell the traders which particular currency is likely to face volatility. Instead of giving the country name or flag, some economic calendars may give the currency of a country.
- Volatility Indicator: This is show in several formats. Some will show stars, others will show exclamation marks, yet others will show simple color codes. Exclamation marks may be color coded as well. There are only three ranges – high, medium and low. Some economic calendars will actually use the texts high, medium and low with color codes.
- Fundamental Indicator/News Release: This column gives you the fundamental indicator or news release that should be traded. Here you get to click on links that will give you a few details about the source of information, information about the indicator and what it means, which economy will be affected by news release, etc.
- Actual Numbers: This column will show the actual result of the news release.
- Expected Numbers: This column will tell you about what was being expected.
- Previous Numbers: This will show you the previous numbers before the news release.
- Revisions: This will show the actual revision that took place from previous to actual numbers.
An Example of a Typical Economic Calendar
Here is a screenshot of an actual economic calendar. You can see the different columns. The volatility indicator is depicted by red bull heads. The greater the number of red bull heads, the greater is the volatility.
Here is another screenshot which shows what you see when you click on the News Release link or the ‘plus’ sign that can be seen on the extreme right of the above image:
How to Use Economic Calendar?
First step is to look at the time. This will tell you when you can expect the market to become volatile for a particular news item. Too much volatility means high risks and if you don’t want your trade to be exposed to high risks, you can consider closing any open position. However, if you are an avid risk lover and want to take advantage of the volatility, it is all up to you.
Next step is to look at the volatility indicator. Items with less volatility can be ignored. Once you identify the high volatility news items, look at the country and the currency that will be affected. This is important because it may not be the case that at the time of the news release the currency of the affected country is being traded.
Once you take a look at the volatility, it is very important to take a look at the Actual Numbers and Expected or Predicted Numbers. The rule of thumb is that if Actual Number is greater than the Predicted Numbers, the market is bullish. In other words, people think that the value of the news item will go up. If however, the Actual Number is smaller than the Predicted Number, the market is bearish. This means people think that the value of the news item will go down.
Consider the following example as we see in the image below:
The image above shows the reports of US Retail Sales. The three bull heads (volatility indicator) shows that the USD will be volatile. The Actual Numbers is 0.4% which is below the forecast or prediction value of 0.8%. So, the markets will be bearish.
There are two possible outcomes here:
- You were trading in a different currency pair, say EUR/JPY before the news release.
- You were trading in USD/JPY or any other currency pair where one of the currencies is USD.
If you are a risk averse person, you will either want to continue trading in EUR/JPY and ignore the volatility or you if were trading in USD/JPY, you may consider closing the open position simply because you do not want to expose your trade to the risks of highly volatile market.
Alternately, if you are a risk lover person, you can do the following:
- Close the existing EUR/JPY trade or leave it as it is.
- Open a new trade with a new currency pair where at least one currency is USD. For example, you can open a trade with USD/JPY to take advantage of the volatile market.
- Since the Actual numbers are lower than the predicted numbers, you will opt for Put option because USD will become weaker compared to JPY. So, if previously 1 USD was equal to 100 JPY (just an assumption), with the value of the USD going down, 1 USD will now be equal to 99 JPY (again an assumption). So, USD/JPY actually goes down and hence, the Put option.
Here we took the example of currency pairs. But what about the other types of underlying assets? Here is a quick analysis:
According to the above example USD is bearish. This means that the value of USD is falling and hence, the US stocks will lose value. So, US stocks will be bearish too! You can use Put option and open new trade positions. Though the economic calendar may look intimidating, gradually you will start to grasp the whole concept. It is always useful to use the economic calendar when you are trading in binary options.