Trading Price Momentum
One of the biggest keys to understanding how trading in the forex market works is to know how momentum affects price action. Traders need to gauge the market extremely carefully as price action can turn in direction, in a split second, based on a momentum occurrence, such as an economic data release, market rumours, and economic news commentary. It is essential that traders have contingency plans in place in the event of huge momentum moves. This could be by implementing stop losses, limit orders, hedging strategies, but importantly, being aware of market conditions and potential events that might cause huge liquidity and momentum shifts in price action.
Causes of trading price momentum are such things as government elections, war, OPEC meetings, and announcements pertaining to oil prices, commodity forecasts, government policy, currency devaluations, exchange rate pricing, debt defaults, market collapse, the US Federal Reserve, political referendums and economic data releases. During these events we will usually find a great deal of speculation due to market sentiment, risk-on and risk-off events, institutional investments including position-taking, and stop-loss activity.
The big players cause the big moves because of their size and liquidity, and they typically include hedge funds, sovereign wealth funds, governments, and their central banks. When these guys come to the market, it is not unusual for them to trade in sizes of over 100,000 US dollars per pip in the Forex market. This type of size causes market makers – that’s those who provide the bids and offers – to very quickly adjust their liquidity support in the market, which further adds to the momentum.
Let’s take a look at the example ‘A,’ this is a 1-hour chart of the USDJPY pair covering the last couple of days. At position 1, we note a huge spike higher in the pair with the 1-hour candlestick breaching the Bollinger bands, whilst spiking through an area of resistance caused by the sideways trading of this pair, and which reaches across, to the left of our chart. Even though the Federal Reserve cut their short-term interest rate by 25 basis points – the third cut this year – which caused this market reaction.
One might have thought that the US dollar would have lost ground against the Japanese Yen because of a lowering in interest rates, which, of course, is less than appealing to investors holding dollars. However, traders took into account that the subsequent forward guidance speech given by Federal Reserve Chairman, Powell, gave no indication that further interest rate cuts were imminent this year. Also, Federal Reserve governors voted 8 to 2 in favour of the cut. This shows that there is some conflict within the Federal Reserve regarding monetary policy.
Indeed the next hourly candlestick shows a pullback in this pair, thus negating the 30 or so pip move to the upside. This spike would have caused many institutions to suffer from a stop loss as price action moved above the key 109.00 level, while traders tried to decipher the implications of the rate cut, and what messages could be gained from Fed Powell’s speech.
Now let’s turn our attention to position 2, we can see a strong bearish candlestick just below position 2, which was a result of a news release stating that a Chinese official reported that the long-awaited part 1 of the Chinese & US trade agreement might not be signed next month as per market expectations. The Chinese official also stated that there was a risk that the deal may collapse due to what they said was a divisive attitude to the agreement by President Donald Trump.
These are just two examples of how price momentum can cause huge amounts of volume and volatility, and whereby in a relatively short time frame, we can see swings in the price action of over 100 pips in this example.
Let’s look at example B. This is a one-hour chart of the US DOW Jones 30. In position 1, we can see a surge in the price action to the upside after the announcement of the 25 basis points rate cut. This is important because US companies can borrow money more cheaply with lower interest rates. We subsequently see a slight pullback of price action inside the Bollinger bands and a consolidation to position 2. The bearish candlestick at this point takes out most of the previous day’s bull trend as soon as the rumour from the Chinese official that the US-China trade deal could collapse. The upshot of these two events was a 400 point swing in price action!
Here at Forex.Academy, we always advise traders to be aware of potential momentum moves in price action. This can only be achieved by having a good overall market awareness, and learning the art of expecting the unexpected, and by having contingency plans in place in the event of such events.