Every first Friday is usually an important day in the financial market. That’s because the US Bureau of Labour Statistics (BLS) usually publishes the previous month’s nonfarm payroll (NFP).
The common challenge among most new traders is that they don’t know how to read, interpret, and use these numbers in their trading.
In this article, we will look at what an NFP is, the most important numbers in the report and how you can trade it well.
What Nonfarm Payrolls are
This is the most-watched number by market participants. It basically shows the total number of jobs that were created in the economy in the previous month. The number is known as nonfarm because it excludes people working at the basic level of the agricultural sector.
However, this is not the only NFP data that market participants watch. They also watch a revision of the previous month’s data.
Two days before the official government NFP data, market participants usually receive unofficial data from Automatic Data Processing (ADP). ADP is one of the biggest employee management companies in the United States.
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Why the NFP is important
There are several reasons why day traders watch the NFP closely. First, it sends an update about the overall health of the American economy. In most cases, the economy tends to create a lot of jobs when the economy is doing well.
For example, at the height of the coronavirus pandemic, the US economy lost close to 20 million in a month as states implemented lockdowns. Similarly, during the Global Financial Crisis of 2008/9, the economy lost millions of jobs.
Second, the NFP data tends to signal what the Federal Reserve will do. When the NFP data disappoints, it is usually a sign that the bank will cut interest rates in its bid to stabilize and stimulate the economy.
Lower interest rates or a dovish Federal Reserve is usually bearish for the US dollar while higher rates tend to be good for the dollar. A stronger dollar, on the other hand, tend to hurt stocks.
Another number that is watched closely is the unemployment rate. This number measures the percentage of people of working age who are not employed.
A smaller unemployment number is usually better than a bigger one. This is because the economy tends to do well when most people are working.
At the height of the coronavirus pandemic, the headline unemployment rate rose to almost 15%. This was the worst performance since the great depression. To deal with the crisis, the Fed responded by slashing interest rates and implementing its biggest quantitative easing program in history.
A closely-watched unemployment rate is U6. U6 is an unemployment rate that includes also the people of working age who are working part-time for economic reasons. The U6 unemployment rate rose to more than 20% during the pandemic.
A common concept in economics is known as the Philips Curve. The theory behind it states that the rate of inflation tends to rise in a period of the low unemployment rate. This is because companies tend to increase their wages to attract more talent.
However, this has not been the case in the United States and in other developed countries like Japan and the European Union.
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Jobs data are not enough without a review of wages. This is because an economy is not viewed to be successful if there are so many low-paying jobs. Also, the lack of wage growth will not lead to inflation.
In most periods, a high nonfarm payroll data and a low unemployment rate usually leads to higher wage growth. That’s because a tightening labor market leads to competition for talent. When new hires are rare, it usually leads to higher wages.
However, something unique happened during the pandemic. While more people lost their jobs and unemployment rose, the overall wage growth improved. That’s because many companies like retailers boosted their employees salaries.
In most cases, a combination of higher wage growth, low unemployment, and high job additions will lead to tightening by the Federal Reserve.
Another important concept watched by market participants is participation rate. The participation rate is the percentage of people of working age who are working or actively looking for work.
How to Trade Nonfarm Payroll Data
A common mistake many traders make is to trade based on the numbers. In this, they will receive a good jobs number and then rush to buy the dollar. In most cases, the dollar moves inversely to the jobs number because the data was already priced-in by the markets.
The NFP data tends to offer significant trading opportunities. Unfortunately, many traders don’t know how to take advantage of these opportunities. They will buy the US dollar and stocks when the NFP numbers are good. In theory, this is the best strategy.
However, in practice, it tends not to work out well.
As a trader, you should do several things. First, consider the estimates by analysts. If the final number beats the estimate by far, it could be a sign that the economy is indeed outperforming. This could be a sign that the Fed will hike rates, which could be negative for stocks.
Second, always consider the technical patterns of the asset. For example, you should map the important levels of support and resistance before the data comes out. This will help you identify key levels when the data comes out.
Third, you should have the bigger picture. This means that you should always factor in the recent statements by the Federal Reserve and the other data like inflation and retail sales.
Finally, consider using limit orders when trading NFP data. These orders include buy and sell stops and buy and sell limits. They will help reduce the risk of using market orders such as slippage.
How the NFP impacts the market
The Non-Farm Payrolls (NFP) has an impact on all financial assets in the United States and around the world because of its impacts on interest rates.
A strong NFP when is accompanied by high inflation is a sign that the Federal Reserve will continue hiking interest rates. Therefore, in most cases, the following assets are impacted:
- Bonds - Strong jobs numbers tend to push bond yields higher since it increases the possibility of more rate hikes by the Federal Reserve.
- Stocks - Good news tends to be bad news for American stocks since better numbers lead to possibility of more hikes. As such, is not uncommon for key indices to retreat after positive numbers.
- Cryptocurrencies - Digital currencies tend to fall after strong jobs numbers and rise when they disappoint.
- Commodities - Commodity prices like gold and silver usually retreat after strong numbers.
Strategies to trade the NFP
Traders use several strategies to trade NFP data. Some of the most popular approaches are:
- Trend-following - This is a strategy where they buy stocks or any other asset when they are in an upward trend. Traders use indicators like moving averages and Bollinger Bands in trend following.
- Trend fading - This is a strategy where a trader goes against the trend hoping that it will reverse. In most cases, traders fade the initial move. For example, if the stock rises after the data, traders can place a trade in the opposite direction.
- Scalping - This is where a trader enters several trades after the NFP data and take several small profits.
- Arbitrage - This is where a trader takes two trades in the opposite direction. For example, a trader can buy the Nasdaq 100 and short the S&P 500 indices. In this case, the profit will be the spread between the profit and loss.
External useful resources to understand nonfarm payroll
- Employment Situation Summary - Bureau of Labor Statistics
- Non-Farm Payroll Definition - Investopedia