Advanced trading strategies
How to trade non-farm payrolls: the V-shaped reversal
The next strategy revolves around the popular method of trading with the non-farm payrolls (NFP).
- What is the NFP V-shaped reversal?
- Trading the V-shaped reversal
- An example of the NFP V-shaped reversal
What is the NFP V-shaped reversal?
The V-shaped reversal is a sharp turnaround that can arise as traders digest the non-farm payrolls report.
The NFP V-shaped reversal is straightforward to execute if you manage your risk carefully, apply a few basic rules and stick to them. It can provide a useful way to trade the non-farm payrolls report, which is notoriously tricky to predict, with a high margin for error.
NFP and the US dollar
Counterintuitively, a strong NFP report can often lead to weakness in USD. This is because a large increase in US employment is indicative of a growing global economy, which can prompt traders to sell safe-haven currencies like the dollar and buy higher-yielding currencies from other regions.
Economic releases typically result in predictable market outcomes. For instance, if GDP growth expands more quickly than expected in Australia, AUD will rally the vast majority of the time.
The NFP report, on the other hand, can be much more dynamic. Major currency pairs such as USD/JPY and EUR/USD may spike in one direction in the wake of the release, then sharply reverse in the following 10-120 minutes. Often, this new trend then continues for the remainder of the session.
Trading the V-shaped reversal
To trade the V-shaped reversal, you first hold off from opening your position as the report is released. Then, you can try to catch the V-shaped reversal if it arises. As we’ve covered, the reversal can often lead to a strong trend, so it may offer an opportunity with a solid risk-reward ratio.
The best method to catch the V is to watch for a reversal candlestick pattern on a 5-minute or 15-minute chart. Though a reversal is not inevitable (nothing in trading is), even catching a reversal 33% of the time can lead to a profit, if you utilize a strong risk-to-reward ratio.
The plan, then, is to wait for a reversal candlestick in the aftermath of an NFP release. Then, open your position with a stop in place nearby, targeting a 1:3 or even 1:4 risk-reward ratio.
An example of the NFP V-shaped reversal
For a quick example, let’s look at the 5-minute chart below. The NFP report printed at 146K, beating expectations of 89K.
Here, EUR/USD initially dropped by around 30 pips in the ten minutes after the data was released. But then a hammer candlestick suggested a shift from selling to buying pressure. This candlestick pattern signaled a possible reason to enter the market on the long side.
A buy order near the close of the candle (around 1.2890) with a tight stop-loss order below the recent low (near 1.2875) would have given a low 15 pips of risk.
Then EUR/USD rallied to 1.2950, over 60 pips above the entry signal. Our trader could have set a limit order based on a 1:3 ratio and banked 45 pips.
If the V hadn’t arrived this time around, you’d lose 15 pips when your stop triggered.