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Before you make gazillions of money off trading the report, the first question you should ask yourself is:

“What the heck is the U.K. GDP?!”

Gross domestic product (GDP) is basically a measurement of the total value of goods and services produced within the United Kingdom. The basic formula for GDP is this:

GDP = consumer spending + investment (by businesses) + government spending + net exports

That means if you sold trench coats in Edinburgh, or if your boyfriend exported tea in Plymouth, or the government decides to put up a soccer field in Cardiff, it would all contribute to the U.K.’s GDP.

Markets usually pay attention to this figure because it serves as a measuring stick of the performance of the U.K. economy. The preliminary report is released about 3 weeks after the end of the quarter and provides the earliest signal of how hot or cold the economy is. Moreover, the Bank of England uses it to help its members decide what stance to take with regards to monetary policy.

Tomorrow the initial results for Q2 will be available at 8:30 am GMT. Word in the FX-hood is that the U.K. economy grew by just 0.2%, after showing a 0.5% figure for the first quarter. The somewhat low expectation isn’t surprising, if you ask me.

Even though core retail sales and manufacturing production exceeded expectations last month, people going off on vacation during the Easter holidays and the Royal Wedding, as well as slower demand thanks to Japan’s earthquake, all could have led to a drop in demand.

Looking back over the past 10 releases, only once has the report come in on target. 7 times it was worse than expected and twice, it managed to exceed expectations. With those types of odds, there’s a good chance we’ll be in for a surprise tomorrow. And we all know what missed targets mean – wild moves on the charts!

Lucky for us, the past three releases give us glimpses of how GBP/USD reacted to the GDP release that came in better, worse, and as expected.

10/26/2010 UK GDP

Last October 2010, the U.K.’s GDP came in twice as big as markets had expected. As we can see, price responded positively to the report and rocketed by as much as 120 pips in the first 30 minutes. During the U.S. session it pulled back by 70 pips, but the pair still managed to cap the day 160 pips higher than its opening price.

01/25/2011 UK GDP

On January 25, 2011 the U.K.’s GDP disappointed expectations. Once again, price reacted in positive correlation to the report, and dropped by 130 pips on the first 30 minutes. At around 2:00 pm GMT during the U.S. session the pair went back up by 55 pips and ranged around the area until the end of the day. Are we seeing a pattern here?

04/27/2011 UK GDP

If GBP/USD rises on a positive GDP report and falls on a disappointing one, how will it react if it comes in AS EXPECTED? Let’s take a look at April 2011’s release when that’s exactly what happened. As it turned out, Cable reacted the same way it did if the report was positive. Price shot up by 120 pips on the first 30-min candle, showed a 65-pip retracement near the end of the London session, and proceeded to end the day 160 pips higher than its open price.

Taking the examples above into consideration, we can say that

  • GBP/USD has a positive correlation with the GDP report.
  • Near the end of the European session, price tends to retrace half of the gains/losses it made during the first 30 minutes of the release.
  • GBP/USD’s closing price for the day is heavily influenced by the GDP report.

If you’re a news trader who is planning to trade this particular report, then the best strategy is probably to buy GBP/USD if the GDP comes in higher than 0.2% and sell it if the report disappoints expectations. In addition, 100 pips is a reasonable profit target if you’re willing to take profits at the close of the first 30-minute candle. Lastly, the U.S. session is a good time to hunt for a cheaper price to buy/sell the pair if you want to add to your position instead of closing it.

So, are you betting the farm on this report? YOU SHOULDN’T! Remember that these are just three samples, and that a lot of other factors like the EU and the U.S. debt crisis can still influence GBP/USD’s price action.

Besides, what if Chuck Norris trades against the usual price action? We wouldn’t stand a chance! What I’m saying is, the strategy I presented above is just a guide and must not be taken as the final word (though that would be awesome). After all, there’s no such thing as a sure thing.

Good luck in trading this report, brothas!