The Fundamentals of Forex - Lesson 1 PMI
In the next following days I am going to work on a full education course designed for understanding the fundamentals behind Forex market and at the same time showing how it can be used for days trading using fundamental news strategy.
Our first lesson : U.S. ISM Manufacturing Purchasing Managers Index (PMI)
Understanding the ISM Manufacturing PMI and Non-Manufacturing Reports
The Service and Manufacturing sectors comprise the majority percentage of US GDP. As such it is important to gauge the overall health of these components. One of the most useful sentiment studies that can help traders and investors to forecast future economic trends is the ISM PMI Manufacturing report, and the ISM Non-Manufacturing report.
What is the ISM Non-Manufacturing Report ?
The Non Manufacturing Purchasing Managers Index (PMI) is released by the Institute of Supply Management (ISM). The Institute was founded in 1915, and was the first supply management institute in the world. The report on business is a composite index that helps measure the economic health of the US economy.
Though the Manufacturing PMI has been around for much longer, there was a need to measure the economic situation within the service sector as well. This is especially true since the service sector is attributed a majority percentage of US GDP in real terms As such the ISM Non-Manufacturing report was born. This report has been published by ISM starting in 1998.
The data is compiled from surveys of approximately 400 purchasing managers in over 65 various non-manufacturing industries including mining, agriculture transportation, retail, and more. The report is released on a monthly basis on the third day of each month and reflects the data for the previous month. The Non Manufacturing Composite Index (NMI) is based on four equally weighted indicators: New Orders, Business Activity, Employment, and Supplier Delivery. All of these indicators are seasonally adjusted expect for the Supplier deliveries.
Generally speaking, when the index is over 50, it demonstrates that the economy is growing, while an index of less than 50 signals a contracting economy. In addition, a better than expected reading is usually bullish for the US Dollar, and conversely a lower than anticipated reading is usually bearish for the US Dollar. Positive readings over time will also tend to help boost stock prices.
Typically, the ISM Non-Manufacturing Index has a somewhat diminished market impact compared to the Manufacturing PMI release. One reason for this is that the non-manufacturing sector is generally much less volatile and more foreseeable than its US Manufacturing Index counterpart.
What is the ISM PMI Manufacturing Index ?
PMI Manufacturing Index on trading view MAN_PMI chart
It measures the manufacturing output for a particular time horizon. The ISM PMI Manufacturing report is released every month, on the first business day of the month. The data reflects the prior month’s activity.
The manufacturing sector is an integral component of the overall economic health of a country. Although the manufacturing sector of the US economy is less than 15% of total GDP, it is nevertheless an important economic report and often highly watched by many Forex traders.
The report is produced by ISM and is a diffusion index, which basically means that it has various components that comprise the index. The resulting number is then updated to take into account seasonality factors. The PMI Index composite takes into account the following indicators: New Orders, Employment, Supplier Deliveries, and Inventories.
The ISM Manufacturing report is gathered by surveying over 400 Purchasing and Supply managers about their future expectations on production, inventories, employment, and new customer orders. The benchmark number is 50 for the index. So, if the number is higher than 50 then this hints of economic growth, while a reading of 50 or lower is considered to be contractionary.
The ISM PMI index is considered to be a leading indicator. It helps foretell future spending and expenditures that contribute to economic expansion. The indicator tends to reflect changes before the economy does. If there is an uptick in the PMI index, meaning there is more manufacturing output, then this is likely to lead to stronger economic considerations. And contrary to this, if there is a downtick in the PMI manufacturing index, meaning there is less manufacturing output, then this is likely to lead to weaker economic conditions.
Trading the ISM Numbers
As we have learned in the earlier section, an ISM composite index number above 50 indicates that the US economy is expanding. In addition, when the number has been above the 50 baseline for several months, it tells us that the economy is stable and strong.
Conversely, when the number is below 50 it indicates that the US economy is contracting. And a number that has been below the 50 baseline for several months, can warn us of a potential recession.
Aside from the longer term forecast that we can make using the ISM figures, short term traders, can take advantage of the ISM economic release for short term price movements. One of the more popular types of news trading methodologies using the ISM report is to trade a divergence between expected results and the actual figure that came in.
For example, if economists are expecting a reading over 55 and the actual index composite comes in at 52 or 53, then the market may react to this discrepancy after the release. In this case, fundamental news traders would likely expect the lower than expected figure to be bearish for the Dollar, and a day trading opportunity could exist to ride the short term momentum on a weakening Dollar.
You could sell the USD/JPY pair for example, or buy the EUR/USD pair for a short term day trade or scalp. However, this trading idea is a generalization and traders need to keep in mind other news events and/or technical levels that could override the ISM reading.
Real examples
For this analyse, lets take a look at EUR/USD pair since December 2020 using 15/30min time frame chart.
Rules :
Actual data is lower than forecast -> EURUSD LONG opportunity.
-> USDJPY SHORT opportunity
Actual data is higher than forecast -> EURUSD SHORT opportunity.
-> USDJPY LONG opportunity
Risk reward ratio : 1:1.5 OR 1:2
Also from my volatility calcuations over the last years, I found out that the best it should be to look for 10-20 pips movements in case of EUR/USD after the release of the PMI.
Release Date Time Actual Forecast Previous
Dec 01, 2020 (Nov) 11:00 57.5 58.0 59.3 -> EUR/ USD LONG OPPORTUNITY
In this case we would have won the trade
Release Date Time Actual Forecast Previous
Jan 05, 2021 (Dec) 11:00 60.7 56.6 57.5 -> EUR/ USD SHORT OPPORTUNITY
In this case we would have won the trade
Release Date Time Actual Forecast Previous
Feb 01, 2021 (Jan) 11:00 58.7 60.0 60.5 -> EUR/ USD LONG OPPORTUNITY
In this case we would have won the trade
Release Date Time Actual Forecast Previous
Mar 01, 2021 (Feb) 11:00 60.8 58.8 58.7 -> EUR/ USD SHORT OPPORTUNITY
In this case we would have lost the trade
Release Date Time Actual Forecast Previous
Apr 01, 2021 (Mar) 10:00 64.7 61.3 60.8 -> EUR/ USD SHORT OPPORTUNITY
In this case we would have lost the trade
Release Date Time Actual Forecast Previous
May 03, 2021 (Apr) 10:00 60.7 65.0 64.7 -> EUR/ USD LONG OPPORTUNITY
In this case we would have won the trade
Release Date Time Actual Forecast Previous
Jun 01, 2021 (May) 10:00 61.2 60.9 60.7 -> EUR/ USD SHORT OPPORTUNITY
In this case we would have lost the trade
Release Date Time Actual Forecast Previous
Jul 01, 2021 (Jun) 10:00 60.6 61.0 61.2 -> EUR/ USD SHORT OPPORTUNITY
In this case we would have won the trade
RESULTS
5 Wins and 3 Losses
Giving us a 60% win rate with a risk reward of 1:1.5
Our first lesson : U.S. ISM Manufacturing Purchasing Managers Index (PMI)
Understanding the ISM Manufacturing PMI and Non-Manufacturing Reports
The Service and Manufacturing sectors comprise the majority percentage of US GDP. As such it is important to gauge the overall health of these components. One of the most useful sentiment studies that can help traders and investors to forecast future economic trends is the ISM PMI Manufacturing report, and the ISM Non-Manufacturing report.
What is the ISM Non-Manufacturing Report ?
The Non Manufacturing Purchasing Managers Index (PMI) is released by the Institute of Supply Management (ISM). The Institute was founded in 1915, and was the first supply management institute in the world. The report on business is a composite index that helps measure the economic health of the US economy.
Though the Manufacturing PMI has been around for much longer, there was a need to measure the economic situation within the service sector as well. This is especially true since the service sector is attributed a majority percentage of US GDP in real terms As such the ISM Non-Manufacturing report was born. This report has been published by ISM starting in 1998.
The data is compiled from surveys of approximately 400 purchasing managers in over 65 various non-manufacturing industries including mining, agriculture transportation, retail, and more. The report is released on a monthly basis on the third day of each month and reflects the data for the previous month. The Non Manufacturing Composite Index (NMI) is based on four equally weighted indicators: New Orders, Business Activity, Employment, and Supplier Delivery. All of these indicators are seasonally adjusted expect for the Supplier deliveries.
Generally speaking, when the index is over 50, it demonstrates that the economy is growing, while an index of less than 50 signals a contracting economy. In addition, a better than expected reading is usually bullish for the US Dollar, and conversely a lower than anticipated reading is usually bearish for the US Dollar. Positive readings over time will also tend to help boost stock prices.
Typically, the ISM Non-Manufacturing Index has a somewhat diminished market impact compared to the Manufacturing PMI release. One reason for this is that the non-manufacturing sector is generally much less volatile and more foreseeable than its US Manufacturing Index counterpart.
What is the ISM PMI Manufacturing Index ?
PMI Manufacturing Index on trading view MAN_PMI chart
It measures the manufacturing output for a particular time horizon. The ISM PMI Manufacturing report is released every month, on the first business day of the month. The data reflects the prior month’s activity.
The manufacturing sector is an integral component of the overall economic health of a country. Although the manufacturing sector of the US economy is less than 15% of total GDP, it is nevertheless an important economic report and often highly watched by many Forex traders.
The report is produced by ISM and is a diffusion index, which basically means that it has various components that comprise the index. The resulting number is then updated to take into account seasonality factors. The PMI Index composite takes into account the following indicators: New Orders, Employment, Supplier Deliveries, and Inventories.
The ISM Manufacturing report is gathered by surveying over 400 Purchasing and Supply managers about their future expectations on production, inventories, employment, and new customer orders. The benchmark number is 50 for the index. So, if the number is higher than 50 then this hints of economic growth, while a reading of 50 or lower is considered to be contractionary.
The ISM PMI index is considered to be a leading indicator. It helps foretell future spending and expenditures that contribute to economic expansion. The indicator tends to reflect changes before the economy does. If there is an uptick in the PMI index, meaning there is more manufacturing output, then this is likely to lead to stronger economic considerations. And contrary to this, if there is a downtick in the PMI manufacturing index, meaning there is less manufacturing output, then this is likely to lead to weaker economic conditions.
Trading the ISM Numbers
As we have learned in the earlier section, an ISM composite index number above 50 indicates that the US economy is expanding. In addition, when the number has been above the 50 baseline for several months, it tells us that the economy is stable and strong.
Conversely, when the number is below 50 it indicates that the US economy is contracting. And a number that has been below the 50 baseline for several months, can warn us of a potential recession.
Aside from the longer term forecast that we can make using the ISM figures, short term traders, can take advantage of the ISM economic release for short term price movements. One of the more popular types of news trading methodologies using the ISM report is to trade a divergence between expected results and the actual figure that came in.
For example, if economists are expecting a reading over 55 and the actual index composite comes in at 52 or 53, then the market may react to this discrepancy after the release. In this case, fundamental news traders would likely expect the lower than expected figure to be bearish for the Dollar, and a day trading opportunity could exist to ride the short term momentum on a weakening Dollar.
You could sell the USD/JPY pair for example, or buy the EUR/USD pair for a short term day trade or scalp. However, this trading idea is a generalization and traders need to keep in mind other news events and/or technical levels that could override the ISM reading.
Real examples
For this analyse, lets take a look at EUR/USD pair since December 2020 using 15/30min time frame chart.
Rules :
Actual data is lower than forecast -> EURUSD LONG opportunity.
-> USDJPY SHORT opportunity
Actual data is higher than forecast -> EURUSD SHORT opportunity.
-> USDJPY LONG opportunity
Risk reward ratio : 1:1.5 OR 1:2
Also from my volatility calcuations over the last years, I found out that the best it should be to look for 10-20 pips movements in case of EUR/USD after the release of the PMI.
Release Date Time Actual Forecast Previous
Dec 01, 2020 (Nov) 11:00 57.5 58.0 59.3 -> EUR/ USD LONG OPPORTUNITY
In this case we would have won the trade
Release Date Time Actual Forecast Previous
Jan 05, 2021 (Dec) 11:00 60.7 56.6 57.5 -> EUR/ USD SHORT OPPORTUNITY
In this case we would have won the trade
Release Date Time Actual Forecast Previous
Feb 01, 2021 (Jan) 11:00 58.7 60.0 60.5 -> EUR/ USD LONG OPPORTUNITY
In this case we would have won the trade
Release Date Time Actual Forecast Previous
Mar 01, 2021 (Feb) 11:00 60.8 58.8 58.7 -> EUR/ USD SHORT OPPORTUNITY
In this case we would have lost the trade
Release Date Time Actual Forecast Previous
Apr 01, 2021 (Mar) 10:00 64.7 61.3 60.8 -> EUR/ USD SHORT OPPORTUNITY
In this case we would have lost the trade
Release Date Time Actual Forecast Previous
May 03, 2021 (Apr) 10:00 60.7 65.0 64.7 -> EUR/ USD LONG OPPORTUNITY
In this case we would have won the trade
Release Date Time Actual Forecast Previous
Jun 01, 2021 (May) 10:00 61.2 60.9 60.7 -> EUR/ USD SHORT OPPORTUNITY
In this case we would have lost the trade
Release Date Time Actual Forecast Previous
Jul 01, 2021 (Jun) 10:00 60.6 61.0 61.2 -> EUR/ USD SHORT OPPORTUNITY
In this case we would have won the trade
RESULTS
5 Wins and 3 Losses
Giving us a 60% win rate with a risk reward of 1:1.5
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