Trading the News Releases

News and economic data are the main drivers of market developments, but in a little different way than many traders think. While many novice traders expect important economic events and news releases to be reflected on the price immediately, complain about the irrationality of the market when that doesn’t occur and protest that trading the news is not possible, in fact it is possible, and extremely lucrative in the long term, if one is willing to wait for the payback to arrive. In this article we will take a look at various data types, and attempt to classify them according to a few basic criteria. We will also try to explain how news releases determine market prices in the long term, especially those of greater value and impact on the market. Finally, we will say a couple of word on short term news trading, and how this could be achieved on the basis

In the US most major news releases occur between 8:30 am and 10 am New York time, and consequently trading is also most active and volatile in this period. Option expiries, and market openings take place during this period also, when traders are busy at their desks absorbing and evaluating overnight data, attempting to place all the developments in a general context for usage later in the day. Since volatility is so high in this period, the profit/loss potential is also the highest. It is obvious that proper risk controls and money management techniques will play a major role in our trading method, if we want to avoid being caught in false breakouts and whipsaws.

The markets’ reaction to any type of data is unpredictable. This is not only the case when the news release is in line with analyst expectations, as published by news channels and financial news providers, but also when the release surprised significantly. Sometimes it’s not even possible to predict how volatile the markets reaction will be to the news release. Sometimes the market will move within a range of fifty or more pips in response to data released. Sometimes a 100-pip movements in the span of one or two minutes will be reversed and completely negated by the price action during the rest of the day. Conversely, while news releases are usually the most volatile periods of a typical trading day, a very unusual release may be welcomed with relative calm if the market decides to do so. What is the cause of all this great unpredictability?

During a news release a number of speculators will react immediately, hoping to gain a quick profit and exit. These will create a very brief ballooning of spreads and volume in the immediate term, but also will distort the underlying technical picture greatly. As these initial buyers or sellers exit, momentum traders will attempt to join in and fuel a more sustainable short-term trend with their actions. Depending on the time and liquidity in the market, they may well be successful, but sometimes they too are checked by previously unknown order layers that check the advance of the price. When these absorb the momentum traders, and short term speculative entrants, the initial reaction of the price may be reversed or negated also.

But while this is so, we do not imply that it is not possible to trade the news in the forex market. All that must be born in mind by the trader is that he’s engaging in a game of probability; he must be very well aware that there doesn’t exist a news release that will ensure that the market will move in this or that fashion. Stop loss orders must not be very tight, and leverage must be kept quite low, so that the order we enter can survive more than a few seconds of the initial shock reaction by short-term actors.

The two major problems of trading the news arise out of the difficulty in gaining timely information, and evaluating that in a fast enough manner to facilitate quick entry into a trade. Hence, it is clear that the trader must have a very good idea of what he expects from the news release. Will he only open a position if the data shock the market? What is the threshold value for the data, above or below which a trade is justified? How long will the position be held? Which technical levels constitute the take-profit, or stop-loss orders for the trade? All these must be discussed and determined even before a trade order is entered. News releases must not be periods when the trader will be hesitating and vacillating between the various paths he can take. Instead, he must act like a machine, with almost automated movements, so that he can be immune to the emotional pressures created by the irrational short-term behavior of the market.

The last issue with trading news releases is born of the unreliable nature of the first versions. In fact, studies have shown that the BLS (the Bureau of Labor Statistics), for instance, consistently underestimates job losses in a recession, and underestimates job gains at the beginning of the boom. Nor does the experienced trader have any trouble in acknowledging this fact: revisions which reverse the meaning and character of the initial release are not at all exceptional in the markets. The short-term trader is not much bothered by this fact, but it has great significance for decisions on the long-term positioning.

There are two ways of trading the news.

1.Long term: Several academic studies have established that the impact of some news announcements have their immediate impact spread over a period of weeks and months, instead of the single day in which the markets are thought to discount them. Non-farm payrolls, and to a greater extent, the interest rate decisions of the federal reserve are good examples for this kind of news flow. While the markets react violently and unpredictably in the short term, the mechanisms set up by low interest rates, and full employment (or conversely, high unemployment) have consequences that are relevant to many sectors of the economy, and trading them on a long term basis is certainly possible. The trader who uses this strategy will build up his positions slowly, and will attach greater value to low frequency releases (such as GDP reports), and will wait until the overall picture offers clarity, before he makes his trade decisions.

2.Short term: To trade news on a short term basis, the trader must have a clear criterion on what kind of news will justify a trade. Many news traders seek at least a 50 percent surprise in the data to consider the release tradeable. The novice trader, in turn, can use the initial period of his trading career for perfecting his money management skills. Trading the news on a short term basis can be easy and lucrative if the trader is disciplined enough to cut losses, and accumulate profits, but panic and mood swings, and undisciplined methodology will quickly erase all the gains through shocks and volatility.

These are the various types of indicators which have the potential to cause the greatest short term movements in the markets

Consumer Price Index (CPI)

While very important, the severity of market reaction to CPI releases partly depends on the health of the general economy. In a booming economy, a string of uncomfortably high CPI values will force the central bank to raise rates in order to subdue growth. In a contracting economy, a high CPI value may prevent the central bank from realizing counter-cyclical interest rate reductions. Since central bank rates are so important for determining the tone of economic activity in the long term, markets pay great attention to the value of this indicator. On the short term, of course, these considerations have no relationship to the motives of speculators, but they do present the justification for violent short term price spikes for momentum traders and short-term speculators, if the data surprises in either direction.

Fed decisions

Depending on the nature of the decision, and how surprised by it the market is, the price swings can be very large and the immediate reaction meaningless with respect to the long term direction of the trend. Fed decisions are one of the most anticipated events in the market, and their macroeconomic significance certainly justifies this attitude. The Fed meetings typically last for about two days, beginning on Monday and concluding on Tuesday. Then the decision is released to the public at around 9 pm New York time.

Fed rate decisions can cause large movements if the rate change is different from what was expected by market consensus. In the absence of such a surprise, traders will concentrate on the tone of the statement accompanying the interest rate decision. Depending on how dovish or hawkish the statement is, the markets will readjust their future interest rate expectations, and on that basis they will reprice currency pairs. The repricing period can be quite long, and it’s unwise to expect this process to be completed in the course of a few weeks.

European central banks and the US Federal Reserve usually release their rate decisions during the first week of each month. As most of the important data are released during this first week from around the world, traders are exceptionally nervous and excited, amplifying volume greatly, but also increasing volatility, as the large amount of short term speculative money opens and closes very short-term positions. In fact, some traders turn the typical movements of this period into a trading strategy.

Non-farm payrolls

Sometimes called the mother of all data, on a typical month the time of this release coincides with the most volatile market action. Non-farm payrolls measure the payroll change of the non-farming private and public sectors. Since economic cycles, consumption, and consequently interest rates all depend on the employment situation of the US economy, the non-farm payrolls release is the most closely watched of all indicators.

For the most part, most experienced traders will avoid trading the immediate aftermath of this release, due to the somewhat nutty price action that follows it. If you’ll forgive the expression. On the other hand, if the trader is satisfied that the data release strongly suggests price movement in a direction, he will use the short term fluctuations that occur as a trading opportunity by entering orders that contradict the market’s short term direction.

While this data is so crucial to a nation like the US with a large domestic economy that is less dependent on trade and commerce, its equivalent is not as important for nations like Japan where the dynamics of the domestic markets is closely correlated to the situation of the global economy

The non-farm payrolls data is typically released by the Bureau of Labor Statistics on the first Friday of each month.

Purchasing Managers' Index (PMI)

The PMI provide a very quick and accurate snapshot of the status of the various sectors of the economy. They do not create as much volatility as the other major releases (such as the non-farm payrolls data, or Fed decisions), but as a result they are also more tradable and safer as entry points. Needless to say, a very extreme value can create massive price shocks in either direction, but the real use of this data is for the guidance it provides for predicting the much more important data that is released towards the end of the week. We can trade these releases both on a trend following, or contrarian basis, depending on what our analysis is telling us about market positioning and the fundamental picture.

onclusion

There are many more releases, and the trader can study each of them for creating his own strategy. The key point is protecting ourselves from emotional extremes, and making sure that we only open positions when we are really satisfied with the data release, and are confident that the scenario offers a reasonable profit potential.