Forward Guidance & Fundamental Analysis

The concept of “forward guidance” has been encouraged in the marketplace by the central banks. In fact, the last few years have seen a huge increase in the educational material and emphasize placed on this concept. It was originally intended to make the actions of central banks more transparent and, in the process, help to keep prices stable.

Although the intention is well meaning there are valid arguments which show that this is not an effective concept. Successful Binary Options trading requires fundamental and technical analysis; forward guidance is only useful as a part of the fundamental analysis.

The Federal Reserve started to release its economic projections for the year ahead; this was its attempt to share with the market what it was expecting to happen and help to stabilize prices in the process. However, the actually had the opposite effect! The main reason that it increased volatility in the markets was that a new projection was being released on a regular basis and each one was different to the one before. Traders could not use the information with any degree of certainty and it actually worried the markets as it suggested the Federal Reserve did not even know what it was expecting!

Of course, the Federal Reserve had a good reason for the changing projections. The data on which it was basing its projections could be and was traded, resulting in huge variations in the data on a week by week basis. This makes it extremely difficult to provide any accurate projections.

The Federal Reserve did inspire other central banks to attempt the concept of forward guidance. In fact, the European Central Bank and the Bank of England changed the way they broadcast rate expectations and their decisions based on the idea of forward guidance. The Bank of England is a very good example of the change in policy. It no longer follows a rate change by the Monetary Policy Committee with a press conference only if the rate has changed. Instead it releases the inflation report on the same day as the interest rate announcement. A press conference is called for the inflation report, every tie and the bank can explain why and how it reached its projection figures.

European Central Bank (ECB)

The ECB adopts a different approach. Forty five minutes after a rate decision has been made they will always hold a press conference. This is regardless of whether the rate has changed or not. However, to acknowledge the principle of forward guidance they now make the minutes of their meetings public; allowing anyone to see what they have discussed and how they have reached their decisions. This is the same technique that the Federal Reserve currently uses.

Through these actions all the major central banks are providing guidance on what is expected and likely to happen in the markets. There are projections regarding interest rates, the economy and this can indicate the best place to invest your funds. This information can help to establish the interest rate differential which will allow any trader to select a currency to trade on.

The interest rates and their movements are strong indicators of how an economy is performing. If interest rates are rising then it is likely that the economy is slowing, asset prices will be reducing. In effect a bullish currency will suggest a bearish market.

In fact, equity markets generally recover well in response to the earning season and can avoid the worst of the impact from interest rate cuts or increases. Forward guidance is likely to remain part of government policy despite the fact it is bringing more volatility to the markets, not less.

US Strategy

The US has devised a strategy where the members of the Federal Reserve make projections for the interest rates for the next two or three years. The central bank staff is also producing the same projections and both will be released. Assuming both projections are similar most people will take them as gospel. They will base their trading and investment opportunities and analysis on these facts. Of course if the charts are not closely related it is likely to lead to widespread uncertainty as to what the markets will do in the future.

There is a variety of video analysis available to assist you to both understand the concept and apply it to your trading strategy. This should be used in conjunction with events as they occur in the economic calendar, how these apply to forward guidance and what to consider when forward guidance information is available.

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