The search for an edge in currency trading often takes the trader through incessant back-testing of different indicators, strategies, set-ups, and systems. Some work until they stop working. The markets seem to be irreducibly complex, making it likely that any set-up is at best a rough approximation of the variables that will make a difference.
As a result of this complexity, it is a very difficult challenge to predict future movements based on pure price action. Yet, there are sources that provide leading indications of likely direction in currencies. These sources are not hidden. They are the Central Bank Statements.
Central Banks are the key catalysts for currency directions. By setting interest rates and monetary policy the Central Banks generate either bullish or bearish expectations about the currency direction. Central Bank statements are carefully constructed, where each word is compared to the previous statements.
Any differences between statements impact immediate market reactions. In short, words have become a key variable, and act like a Rosetta stone providing semantic clues behind the decisions.
Central Bank statements can provide actionable knowledge beyond the data release dates. A comparison of keywords used by the Central Banks in recent statements shows a leaderboard of concerns and provides further clues to the coming shifts in currency valuations.
For example, in trading currencies, expectations on inflation become critical to discern. Let’s compare the frequency of the word “inflation” used by different Central Banks in their last statement:
A frequency analysis of the number of times a word is mentioned in Central Bank statements indicates clearly that “inflation” is the major focus of the banks. The takeaway for traders is to be vigilant on CPI data, as it becomes important in confirming whether the Central Banks are getting closer to their 2% goal.
But of significance, is the divergence of the Bank of Canada and Reserve Bank of Australia’s focus from the rest. We see the lack of a high score frequency mentioning of inflation, which indicates a bearish sentiment skew for that currency as their economies are not heating up to warrant expectations of a tightening of monetary policy.
The word cloud on the Australian May 2 rate statement, visually displays the concern is on “growth,” not inflation when compared to the word cloud on the Bank of England’s Rate Decision statement.
It is no coincidence that rates for Canada and Australia have been on hold. For the trader who wants an edge, a close reading of Central Bank rate decision statements provides a different dimension of analysis and meaning compared to viewing the currency pair charts. It may very well be that the edge that is being sought by Forex traders on finding direction can be found in the word clouds.