A Good Way to Trade the News

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How To Trade The News

Two savage bear markets within the first decade of this millennium have made many investors question the wisdom of adhering to a “buy and hold” strategy for stocks. Although equity markets may display a sustained upward trend over long time periods, it’s the intermittent tailspins – such as the 50% plunges endured by most major markets during the 2008-09 global credit crisis – that test the fortitude of any investor.

Trading the news, then, should be an integral component of your investing strategy. While day traders may trade the news several times in a trading session, longer-term investors might do so only occasionally. Regardless of your investing horizon, learning to trade the news is an essential skill for astute portfolio management and long-term performance.

Classifying News

News can be broadly classified into two categories:

  • Periodic or recurring – News that is issued at regular intervals. For example, interest rate announcements by the Federal Reserve and other central banks, economic data releases and quarterly earnings reports from companies all fall into this category.
  • Unexpected or one-time This category includes “bolts from the blue” such as terrorist attacks or sudden geopolitical flare-ups, as well as abrupt market developments on the economic or financial front like the threat of debt default by an indebted nation. Unexpected news is more likely to be adverse than favorable.

News can be specific to a particular stock or something that affects the broad market.

Trading the News

Let’s use a few examples to demonstrate these concepts:

1. Federal Reserve rate announcement: The Federal Open Market Committee’s (FOMC) interest rate announcements have always been among the biggest market-moving events. But in 2020, the Fed’s moves assumed unparalleled importance, as investors waited with bated breath to see if the central bank would continue to inject $85 billion monthly into the U.S. economy through bond purchases (the third round of quantitative easing or QE3), or if it would slow the pace of these purchases. Given that U.S. equity indices were at record highs in October 2020, an investor with a substantial long position in U.S. stocks who was looking to hedge potential downside risk could have done the following right after the Fed’s Oct. 30 announcement:

  • Trimmed positions in highly profitable equity positions to take some money off the table.
  • With market volatility near multi-year lows at that time, the investor could have purchased puts either on specific stocks in the portfolio or on a broad market index like the S&P 500 or Nasdaq 100. Purchasing puts gives the investor the right to sell a stock for an agreed-upon price at some future time. If the security’s market price falls below the agreed-upon price, the investor gains by selling at the higher contractual price.
  • Bought a certain amount of inverse exchange traded funds (ETFs) – which move in the opposite direction of the broad market or a specific sector – to protect portfolio gains.

While these reactive moves would typically be carried out after the Fed announcement, a proactive investor could implement these same steps in advance of the Fed statement. This reactive or proactive approach to an important event or piece of news, of course, depends on a number of factors, such as whether the investor has a high degree of conviction about the market’s near-term direction, risk tolerance, trading approach (passive or active) and so on.

2. U.S. employment situation summary (the “jobs report”): In terms of economic data releases, few are more important than the U.S. jobs report. Traders and investors closely watch the employment level, since it has a substantial influence on consumer confidence and spending, which accounts for 70% of the U.S. economy. Jobs numbers that miss economists’ forecasts are generally interpreted as signs of incipient economic weakness, while payroll numbers that surge past forecasts are seen as strength. In the summer of 2020, investors were unfazed by payroll numbers that came in below expectations, in the belief that any signs of economic weakness would cause the Fed to keep QE3 going. The investor playbook for trading jobs data in 2020 could be easily based on predictable market reaction, which was as follows:

  • Payroll numbers below expectations: Implies that the Fed would be forced to keep interest rates low for an extended time period. The impact on specific asset classes was typically as shown in the table:

Asset/Instrument

Immediate Impact

  • Payroll numbers above expectations: Implies that the Fed may scale back the pace of asset purchases, which could send bond yields and market interest rates higher.

Asset/Instrument

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Immediate Impact

An investor could use these market reactions to formulate an appropriate trading strategy to implement either in advance of the jobs report or after its release.

3. Earnings reports: It is generally advisable to have a trading strategy in advance of an earnings report, because a stock can bounce around in a much wider range post-earnings, as compared to the swings in an index after a data release. Imagine having a huge short position in a stock and watching it soar 40% in the after-market because its earnings were much better than expected.

Trading earnings reports may not be required for every stock in one’s portfolio, but it may be necessary for a stock where the investor has a fairly large position, whether long or short. In this case, the investor needs to weigh the merits of leaving the position unchanged over the earnings report or making changes prior to it. Factors that should play a part in this decision include:

  • The current state of the overall market (bullish or bearish);
  • Investor sentiment for the sector to which the stock belongs;
  • Current level of short interest in the stock;
  • Earnings expectations (too high or comfortably low);
  • Valuations for the stock;
  • Its recent and medium-term price performance;
  • Earnings and outlook reported by the competition, etc.

For example, an investor with a 15% position in a big-cap technology stock that is trading at multi-year highs may decide to trim positions in it ahead of the earnings report, so that it now constitutes 10% of the portfolio. This may be preferable to taking the risk of a steep decline post-earnings if the stock is unable to meet investors’ high expectations. An alternative option could be to buy puts to hedge downside risk. While this would enable the investor to leave the position unchanged at 15% of the portfolio, this hedging activity would incur a significant cost.

It may also make sense to trade an earnings report for a stock where the investor does not have a position but (rightly or wrongly) has a high degree of conviction. Key points to note are – avoid taking an unduly large position, and have a risk mitigation strategy in place to cap losses if the trade does not work out.

4. Bolts from the blue: What should you do if the screens suddenly flash news of a terrorist attack somewhere in the United States, or war looks imminent between two nations in the volatile Middle East? While this is one time when you may need to be proactive to protect your investment capital, a kneejerk reaction to sell everything and take to the hills may not be the best course of action. Over the years, financial markets have demonstrated a great deal of resilience by taking in stride the occasional terrorist attack, such as the bomb blasts at the Boston Marathon’s conclusion on April 15, 2020.

During times of geopolitical uncertainty, it may be prudent to rotate out of more speculative instruments and into higher-quality investments, and consider hedging downside risk through options and inverse ETFs. While you should scale back your equity exposure if it is uncomfortably high, bear in mind that in the majority of cases, the short-term corrections caused by unexpected geopolitical or macroeconomic events have proved to be quintessential long-term buying opportunities.

Tips for New News Traders

  • Know the dates and times of important events: Information on the dates and times of key market events such as FOMC announcements, economic data releases and earnings reports from key companies is readily available online. Know this “calendar of events” in advance.
  • Have a strategy in place beforehand: You should plot your trading strategy in advance, so that you are not forced into making rash decisions in the heat of the moment. Know your exact trading entry and exit points before the action begins.
  • Avoid kneejerk reactions: Rather than kneejerk reactions, make rational investing decisions based on your risk tolerance and investment objectives. This may require you to be a contrarian on occasion, but as successful long-term investors will attest, this is the best approach for successful equity investing.
  • Cap your risk levels: Avoid the temptation of trying to make a fast buck by taking a concentrated long or short position. What if the trade goes against you?
  • Have the courage of your convictions: Assuming you’ve done your homework, consider adding to an existing position if the stock plunges to a level below its intrinsic value, or conversely, selling out to take profits in a stock that is wildly popular at the moment.
  • See the big picture: Often, investor reaction to a development may not be as expected. For example, Canadian natural gas company EnCana (ECA) slashed its dividend by 65% on Nov. 5, 2020. While a dividend cut of this magnitude would normally send a stock plunging, EnCana actually rallied 3% on the day. This was because investors viewed the dividend cut as a cash-saving measure, and they also approved the company’s plans to sell shares in a new royalty company.
  • Don’t be swayed by market sentiment: This is a corollary to some of the earlier tips, and it is important enough in its own right. Being overly swayed by market sentiment may result in too many instances of buying high – when euphoria runs rampant – and selling low, when gloom and doom prevails. Consider the plight of the many hapless investors who were so spooked by the unrelenting tide of bad news in 2008 that they exited their equity positions near the lows, incurring massive losses in the process. Numerous investors failed to get back into equities after that horrendous experience, and in the process, missed out on a stunning gain of 166% in the S&P 500 from March 2009 to October 2020.
  • Know when to “fade” the news: Many times it is as important to ignore the news or “fade” it as it is to trade it. Best Buy (NYSE:BBY) is a great example of a stock where ignoring the steady drumbeat of bad news, and focusing instead on its valuations and turnaround prospects, would have paid off handsomely. The stock was trading at a decade-low $11.20 in December 2020, as it was losing market share to online rivals like Amazon.com (Nasdaq:AMZN) and aggressive retailers such as Wal-Mart (NYSE:WMT). But as of Nov. 6, 2020, it was the third-best performer on the S&P 500 for the year, having nearly quadrupled in price as profits surged thanks to cost-cutting measures and competitive product pricing.

The Bottom Line

Trading the news is crucial for positioning your portfolio to take advantage of market moves and boost overall returns.

How to Trade Forex on News Releases

One of the great advantages of trading currencies is that the forex market is open 24 hours a day, five days a week (from Sunday, 5 p.m. until Friday, 4 p.m. ET). Since markets move because of news, economic data is often the most important catalyst for short-term movements. This is particularly true in the currency market, which responds not only to U.S. economic numbers, but also to news from around the world. Here, we look at which economic numbers are released when, which data is most relevant to forex traders, and how traders can act on this market-moving information.

Which Currencies Should Be Your Focus?

With at least eight major currencies available for trading at most currency brokers, there is always a piece of economic data slated for release that forex traders can use to make informed trades. In fact, seven or more pieces of data are released almost each weekday (except holidays) from the eight major most-followed countries. So for those who choose to trade news, there are plenty of opportunities. The eight major currencies are familiar to most traders:

1. U.S. dollar (USD)
2. Euro (EUR)
3. British pound (GBP)
4. Japanese yen (JPY)
5. Swiss franc (CHF)
6. Canadian dollar (CAD)
7. Australian dollar (AUD)
8. New Zealand dollar (NZD)

And there are many liquid currency pairs derived from the eight major currencies:

Currencies that can be easily traded span the globe. This means that you can handpick the currencies and economic releases to which you pay particular attention. But, as a general rule, since the U.S. dollar is on the “other side” of 90% of all currency trades, U.S. economic releases tend to have the most pronounced impact on forex markets.

Key Takeaways

  • Economic data tends to be one of the most important catalysts for short-term movements in the forex market.
  • Since the dollar is one side of many currency pairs, U.S. economic releases tend to have the most pronounced impact.
  • The most common way to trade forex on news is to look for a period of consolidation ahead of a big number and trade the breakout on the back of the number.
  • A variety of exotic options are available for traders who want to capture a breakout move, but with less volatility than trading the currency pair itself.

Trading news is harder than it may sound. Not only is the reported consensus figure important, but so are the whisper numbers (the unofficial and unpublished forecasts) and any revisions to previous reports. Also, some releases are more important than others; this can be measured in terms of both the significance of the country releasing the data and the importance of the release in relation to the other pieces of data being released at the same time.

When Are Key News Releases?

Figure 1 lists the approximate times (Eastern Time) of the most important economic releases for each of the following countries. These are also the times that players in the forex market pay extra attention to the markets, especially when trading based on news releases.

Country Currency Time (EST)
U.S. USD 8:30 to 10 a.m.
Japan JPY 6:50 to 11:30 p.m.
Canada CAD 7 to 8:30 a.m.
U.K. GBP 2 to 4:30 a.m.
Italy EUR 3:45 to 5 a.m.
Germany EUR 2 to 6 a.m.
France EUR 2:45 to 4 a.m.
Switzerland CHF 1:45 to 5:30 a.m.
New Zealand NZD 4:45 to 9 p.m.
Australia AUD 5:30 to 7:30 p.m.

Figure 1: Times at which various countries release important economic news

What Are the Key Releases?

When trading news, you first have to know which releases are actually expected that week. Second, knowing which data is important is also key. Generally speaking, the most important information relates to changes in interest rates, inflation, and economic growth, like retail sales, manufacturing, and industrial production:

1. Interest rate decisions
2. Retail sales
3. Inflation (consumer price or producer price)
4. Unemployment
5. Industrial production
6. Business sentiment surveys
7. Consumer confidence surveys
8. Trade balance
9. Manufacturing sector surveys

Depending on the current state of the economy, the relative importance of these releases may change. For example, unemployment may be more important this month than trade or interest rate decisions. Therefore, it is important to keep on top of what the market is focusing on at the moment.

How Long Does the Effect Last?

According to a study by Martin D. D. Evans and Richard K. Lyons published in the Journal of International Money and Finance (2004), the market could still be absorbing or reacting to news releases hours, if not days, after the numbers are released.

The study found that the effect on returns generally occurs in the first or second day, but the impact does seem to linger until the fourth day. The impact on the flow of buy and sell orders, on the other hand, is still very pronounced on the third day and is observable on the fourth day.

How to Actually Trade News?

The most common way to trade news is to look for a period of consolidation or uncertainty ahead of a big number and to trade the breakout on the back of the news. This can be done on both a short-term basis (intraday) or over several days. Let’s look at the chart in Figure 2 as an example. After a weak number in September, the euro was holding its breath ahead of the October number, which was to be released to the public in November.

In the 17 hours before the release, EUR/USD was confined within a tight 30-pip trading range. (A pip is the smallest measure of change in a currency pair in the forex market, and since most major currency pairs are priced to four decimal places, the smallest change is that of the last decimal point.) For news traders, this would have provided a great opportunity to put on a breakout trade, especially since the likelihood of a sharp move at this time was extremely high.

The table above illustrates shows—with two horizontal lines forming a trading channel—the indecision and uncertainty leading up to October non-farm payroll numbers, which were released in early November. Note the increase in volatility that occurred once the numbers were released.

We mentioned earlier that trading news is harder than you might think. Why? The primary reason is volatility. You can be making the right move but the market may simply not have the momentum to sustain the move.

Let’s look at the chart in Figure 3 as an example. This chart shows activity after the same release as the one shown in Figure 2 (but on a different time frame) to show how difficult trading news releases can be. On Nov. 4, 2005, the market had expected a payroll increase of 120,000 jobs, but instead the U.S. economy gained only 56,000 jobs. The disappointment led to an approximately 60-pip sell-off in the dollar against the euro in the first 25 minutes after the release.

However, the dollar’s upside momentum was so strong that the gains were quickly reversed, and an hour later, the EUR/USD had broken its previous low and actually hit a 1.5-year low against the dollar. Opportunities were plentiful for breakout traders but bullish momentum in the dollar was so strong that such a bad payrolls number failed to put a sustainable dent in the currency’s rally. One thing you should keep in mind is that, on the back of a good number, a strong move should also see a strong extension.

The chart above shows that, while the worse-than-expected non-farm payroll numbers sent the EUR/USD rate upward for a short period of time, the strong momentum of the U.S. dollar was able to take control and push higher. Keep in mind, when the EUR/USD rate falls, the U.S. dollar is going upward, and vice versa.

Trading News With Exotic Options

One potential answer to capturing a breakout in volatility without having to face the risk of a reversal is to trade exotic options. Exotic options generally have barrier levels and will be profitable or unprofitable based on whether the barrier level is breached. The payout is predetermined and the premium or price of the option is based on the payout. The following are the most popular types of exotic options to use to trade news releases:

A double one-touch option has two barrier levels. Either one of the levels must be breached prior to expiration in order for the option to become profitable and for the buyer to receive the payout. If neither barrier level is breached prior to expiration, the option expires worthless. A double one-touch option is the perfect option to trade for news releases because it is a pure non-directional breakout play. As long as the barrier level is breached—even if the price reverses course later—the payout is made.

A one-touch option only has one barrier level, which generally makes it slightly less expensive than a double one-touch option. The same criterion holds—the payout is only made if the barrier is breached prior to expiration. This is a good option to buy if you actually have a view on whether the number will be stronger or weaker than the market’s consensus forecast.

Options on currencies are a viable alternative for those who do not care to get whipsawed in the markets by undue volatility before they actually see the spot price move in their desired direction; there are different types of currency options available through a handful of forex brokers.

A double no-touch option is the exact opposite of a double one-touch option. There are two barrier levels, but in this case, neither barrier level can be breached before expiration—otherwise the option payout is not made. This option is great for news traders who think that the economic release will not cause a pronounced breakout in the currency pair and that it will continue to range trade.

2 Ways to Trade the News

There are two main ways to trade the news:

a) Having a directional bias

b) Having a non-directional bias

Directional Bias

Having directional bias means that you expect the market to move a certain direction once the news report is released.

Consensus vs. Actual Number

Several days or even weeks before a news report comes out, there are analysts that will come up with some kind of forecast on what numbers will be released.

This number is called a consensus.

When a news report is released, the number that is given is called the actual number.

“Buy the rumors, sell on the news.”

This is a common phrase used in the forex market because often times it seems that when a news report is released, the movement doesn’t match what the report would lead you to believe.

For example, let’s say that the U.S. unemployment rate is expected to increase. Imagine that last month the unemployment rate was at 8.8% and the consensus for this upcoming report is 9.0%.

With a consensus at 9.0%, it means that all the big market players are anticipating a weaker U.S. economy, and as a result, a weaker dollar.

So with this anticipation, big market players aren’t going to wait until the report is actually released to start acting on taking a position.

They will go ahead and start selling off their dollars for other currencies before the actual number is released.

Now let’s say that the actual unemployment rate is released and as expected, it reports 9.0%.

As a retail trader, you see this and think “Okay, this is bad news for the U.S. It’s time to short the dollar!”

However, when you go to your trading platform to start selling the dollar, you see that the markets aren’t exactly moving in the direction you thought it would.

It’s actually moving up! What the heck! Whyyyyyy??

This is because the big players have already adjusted their positions way before the news report even came out and may now be taking profits after the run-up to the news event.

Now let’s revisit this example, but this time, imagine that the actual report released an unemployment rate of 8.0%.

The market players thought the unemployment rate would rise to 9.0% because of the consensus, but instead, the report showed that the rate actually decreased, showing strength for the dollar.

What you would see on your charts would be a huge dollar rally across the board because the big market players didn’t expect this to happen.

Now that the report is released and it says something totally different from what they had anticipated, they are all trying to adjust their positions as fast as possible.

The only difference would be that instead of the dollar rallying, it would drop like a rock!

Since the market consensus was 9.0% but the actual report showed a bigger 10.0% unemployment rate, the big players would sell off more of their dollars because the U.S. looks a lot weaker now than when the forecasts were first released.

It’s important to keep track of the market consensus and the actual numbers, you can better gauge which news reports will actually cause the market to move and in what direction.

Non-directional Bias

A more common news trading strategy is the non-directional bias approach.

This method disregards a directional bias and simply plays on the fact that a big news report will create a big move.

It doesn’t matter which way the forex market moves. We just want to be there when it does!

What this means is that once the market moves in either direction, you have a plan in place to enter that trade.

You don’t have any bias as to whether the price will go up or down, hence the name non-directional bias.

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