Trading under normal market conditions usually involves taking on some risk, but news trading can be much riskier. For this reason, many conservative traders prefer to stay out of the market immediately before and after the release of important economic reports and other data.
However, other traders can use strategies that take advantage of the strong bursts of volatility often seen after a certain news release. They usually keep a close eye on the market during these events and try to react quickly to price changes. At the same time, they maintain strict trading discipline in order to quickly open and close their positions during such risky events.
News trading is becoming more and more popular among traders because it offers the opportunity to make big profits in a short period of time. However, not all economic events have the same impact on the market. For example, the German PMI index will always have a larger impact on the euro compared to the French PMI.
The following sections of this article will introduce key concepts related to news trading and will mention some of the popular trading strategies used to take advantage of significant market movements that may occur during a scheduled news release.
News Trading: Understanding Market Consensus
One of the most important concepts to understand when considering news trading is the concept of market consensus. Simply put, it is the expectation of financial analysts and market participants for a particular economic report.
Some market events, such as major natural disasters and political events, may come as a surprise to most market participants. However, the timing and even the approximate outcome of most noteworthy events can be predicted in advance with reasonable accuracy in many cases by economic forecasters.
Individual analysts may use financial models, their personal research, consumer confidence reports, and other tools at their disposal to arrive at an expert opinion on the likely outcome of important economic data releases. As many analysts publish their views, a market consensus is eventually formed by which the actual outcome of a news release will be judged.
If the observed result is better than the consensus expected, the market may react favorably. On the other hand, if the result turns out to be worse than the consensus, then the market will be disappointed and most likely will react unfavorably. The result in accordance with the consensus, as a rule, has a relatively neutral impact on the market.
Buy on hearsay, sell on facts
Perhaps one of the main principles of trading most often shared by experienced traders is the saying:
Buy on hearsay, sell on facts.
While this saying probably originally applied to the stock market and therefore seems biased towards those who are going to go long, its wisdom can easily be applied to other financial markets, including the forex market.
The essence of this advice is based on the observation that markets often move ahead of a major news event or economic data release due to rumors about what the outcome will be. Traders in large financial institutions often take positions based on these sources of information, and they often talk to each other about their positions as well as follow the advice of well-known economists.
As soon as the data is published, traders immediately compare it with the market consensus and evaluate their forecasts depending on whether the result was favorable or disappointing. In addition to this effect, large market players who took positions before a news event by rumor or analysis subsequently close them as soon as the actual result becomes a known fact. This effect can lead to significant illogical changes after the release of the news.
For example, a fund manager may have heard a rumor that the Federal Open Market Committee, or FOMC, which sets benchmark interest rates in the United States, is strongly considering raising rates if this month's Non-Farm Payrolls are at their strongest. expect.
Therefore, he may go long the US dollar against the euro before the Non-Farm Payrolls data is due, expecting the EUR/USD exchange rate to fall by a significant number due to increased interest rate hike expectations. Then, when the data turns out to be more favorable than the consensus, as he expected, he will take any subsequent rate cut as an opportunity to quickly balance his position, since he will probably already be satisfied with his position.
If large enough players trading on such rumors do the same thing, then an illogical movement can occur in the market, when the price initially moves in one direction, but then reverses sharply at the moment when profit-taking begins.
What is the best way to trade on the news?
If you open the economic calendar, you can see which news has more impact on the market and which does not, and which you can easily ignore. For example, if you are trading the Australian dollar, you can ignore the Conference Board Index as it is unlikely that this report will affect the price of AUD/USD or AUD/CAD, and even if it does, the price movement will probably not be able to change the prevailing trend.
However, there is news that will have serious consequences for the AUD / USD or any other currency pair involving the Australian dollar. It could be the unemployment rate in Australia or the interest rate set by the Reserve Bank of Australia.
What news events should you follow? The good news is that, as with the Pareto principle, only a few news reports affect the price movement for most currency pairs. Some of these news events are common to almost all currencies, and if you understand how they affect your favorite currency pair, then you will have an advantage over most beginner traders who only look at the chart.
Although trading during important news events can be an important part of the strategy for a trader who bases his trading decisions on fundamental analysis , many technical analysis traders will do their best to analyze their trading positions before such events.
Often, avoiding the excessive volatility associated with news releases can seem very prudent to them.
Technical traders may take into account that if the information has not yet been released to the public, it cannot be fully discounted once released, and therefore the fundamental principle of technical analysis is temporarily violated. Once new information is released to the market, technical analysis methods can be applied again with more confidence and better results.
Even fundamental traders may not have deep enough pockets to withstand the often unexpected market moves that are sometimes seen around major news releases. Very wide spreads and order slippage at such times can make even the most staunch trader wary of holding or opening positions in such trading conditions.
In addition, due to the high risk of volatility around important news releases, many traders who wish to hold positions above news releases often decide to at least reduce their position sizes. This sensible response to more risk is a component of a money management strategy that should be included in your trading plan.
What tools will help you follow the news?
Perhaps one of the most important tools is the economic calendar .
A suitable economic calendar will typically list all relevant events occurring on each trading day for each currency, prioritizing them in terms of their potential impact on the market, when they were released, market consensus, and what the previous outcome was. Once the data is released, it should also update quickly on the calendar.
Another key tool for the currency news trader will be real-time access to an authoritative financial news channel that quickly publishes news related to the currency market and the results of all major economic publications. When it comes to making trading decisions based on news events, the more timely the news, as a rule, the better your results.
Key economic reports
The most important economic reports that affect currency rates and are most traded by traders include the following:
interest rate decisions. Typically, central bank rate decisions cause the most volatility, especially when the interest rate hike or cut was unexpected.
Inflation data - the level of commodity prices in a country and whether prices are rising or in a range can significantly affect the monetary policy of a central bank.
Basic job data. The unemployment rate and the number of people receiving unemployment benefits serve as a barometer for the economic health of a nation. Non-pharma data is one of the most monitored economic indicators and can have a significant impact on the market.
Preliminary data on GDP. A country's gross domestic product is one of the most important indicators of the health of an economy.
Trade balance and current account data. Changes in the balance between a country's imports and exports have a significant impact on the currency.
national elections. The political climate of a country has a significant impact on the country's currency, especially if there is a major economic change.
Referendum results. Public votes on such important national issues as, for example, staying in or leaving the economic bloc, can significantly affect the value of the country's currency.
Unemployment rate
All major monetary policy decisions made by the central bank are based on the current level of unemployment and inflation.
All countries publish unemployment rate statistics every month. This report directly affects the valuation of the currency. The expectation of higher inflation and higher interest rates is closely related to the unemployment rate. Consequently, the unemployment rate is a leading indicator of future monetary policy decisions.
Unemployment rates in the UK and the European Union:
Currently, the unemployment rate in the EU is much higher than in the UK. Therefore, a simple analysis shows us that the euro should be worth less than the British pound (EUR/GBP).
If you see a consensus that the unemployment rate in the European Union will decrease next month, but it will remain unchanged in the UK, you can consider this as bullish news for the EUR/GBP currency pair.
Gross domestic product (GDP) growth rate
Gross domestic product (GDP) measures the overall health of an economy. The higher the GDP growth rate, the stronger the currency will be. If you trade the GBP/USD pair and keep an eye on US and UK GDP growth, you can easily determine which way the currency pair will move in the coming weeks.
US and UK GDP Growth Rates:
You can see that the US GDP growth rate is usually close to that of the UK. However, one indicator often outperforms the other. When you see that the US GDP growth rate is higher compared to the UK growth rate, you can interpret this as a bearish signal for the GBP/USD. Similarly, if you see a forecast that New Zealand's GDP growth rate will fall compared to that of the UK, it will be a bullish signal for the GBP/NZD.
The release of GDP data leads to a sudden rise in price:
Consumer Price Index (CPI)
The Consumer Price Index (CPI) measures the rate of inflation in an economy compared to a base year. You don't need to be an economist to understand how inflation affects the economy, but some basic knowledge will help you make informed trading decisions. Most central banks have a monetary policy that attempts to limit the rate of inflation to a certain range. When inflation falls outside this range, central banks typically raise interest rates to curb inflation.
Most central banks are trying to limit the inflation rate to 2.0% and use the consumer price index to measure it. However, the Federal Reserve, the US central bank, uses the consumer spending index instead of the CPI. So, if you're trading the US dollar and want to anticipate future interest rate changes, use the PCE index.
However, every time you see a CPI rise forecast, it will be bullish news for the currency. For example, if the forecast for the UK CPI is 2.5% for the quarter, and the Australian CPI remains at 1.5%, then this will be bullish for the GBP/AUD pair.
overnight interest rate
Banks also borrow money from each other, but they do it overnight. Central banks try to influence the overnight rate by lending in the money market at their own overnight rate, and this is an important tool in their monetary policy arsenal.
The overnight interest rate is the main cause of price fluctuations in the market as it also affects the swap rate. In fact, many traders believe that the main purpose of fundamental analysis is to predict the future interest rates of major central banks.
Although understanding monetary policy is difficult even for seasoned economists, the way to interpret this news is quite simple. If you see a forecast that the Federal Reserve is likely to increase the overnight rate, this is likely to be bullish on the US dollar. So, for example, if the central bank of Japan keeps its exchange rate unchanged, it will be part of the bullish news for USD/JPY.
Data on Nonfarm Payrolls (NFP) in the USA
Non-farm payrolls measures the number of additional jobs created in the previous month in the corporate sector in America, which is an important leading indicator of the overall employment situation in the country.
Impact of Nonfarm Payrolls data on EUR/USD:
The US dollar is the world's de facto reserve currency, and non-farm payroll data is typically released on the first Friday of each month by the US Bureau of Labor Statistics (BLS). While there isn't a similar data release for every country, the US NFP should always be monitored as it will eventually have a significant impact on almost all currency pairs, including the US dollar.
If you see that the NFP forecast is higher compared to last month, this is bullish news for the US dollar.
Organization of the Petroleum Exporting Countries (OPEC)
OPEC is an international oil cartel that includes 15 major oil producing countries such as Saudi Arabia, Kuwait, Iran, etc.
Currently, OPEC countries control about 44 percent of the world's crude oil production, and their decision to increase or decrease crude oil production could have a major impact on the global energy market. There is a strong correlation between the foreign exchange market and oil prices.
Due to the impact on the price of oil, OPEC decisions can affect the foreign exchange market, because this affects production on a global scale, and as traders, you should follow OPEC reports.
Crude oil is quoted in US dollars because it is the de facto reserve currency. Therefore, any national currency of a country with a large supply of crude oil will be affected by the price of crude oil.
In addition, low energy prices mean that consumers will be provided with more disposable income, which can create demand for goods and services, boosting sales. Hence, when OPEC increases production, it tends to increase GDP growth in the US, which has a large supply of oil. But this may not have a significant impact on the Japanese yen, because Japan does not have large oil reserves. In this case, USD/JPY will rise because the reduction in oil production will be bullish news for the US dollar.
Retail sales
Retail sales reports are published on a monthly basis and market analysts consider it one of the leading macroeconomic indicators. When consumers feel confident and secure about their jobs, they tend to spend more on durables and non-durables, which drives sales. A strong retail sales figure could be a pretty good indicator of future GDP growth rates.
However, the analysis of retail sales is somewhat complex, as it also depends on wage growth and the overall level of productivity in the economy. Before analyzing the retail sales data, you should keep in mind that while an increase in sales can lead to inflation, it can also indicate overconfidence in the economy. After all, if productivity and wages are not rising, but only retail sales are rising, this could also indicate that people are buying things to store essential goods because they expect the economy to slow down.
Purchasing Managers Index (PMI)
The Purchasing Managers' Index (PMI) is based on a survey of key purchasing managers in the economy. The survey asks managers to evaluate how they feel about the business over a 6-month period, whether they plan to hire new workers or reduce the workforce, as well as things like the level of resources to fill new orders.
The way to interpret PMI is to keep an eye on whether the number is above or below 50. If it is below 50, it indicates a possible recession, and if it is above 50, then the economy is expected to expand.
Usually, the PMI index usually ranges from 55 to 60, but the trick is to see the current trend. If you see the PMI rising consistently over the past few months, consider it bullish for the respective currency. For example, if the UK PMI rose from 52 to 55 over the past few months, while the US PMI only rose from 52 to 53, this would be bullish for the EUR/USD pair.
The release of PMI data leads to a strong price movement:
Housing data
According to the National Association of Home Builders in the US, the housing sector makes up about 15-18% of the economy. While the proportion of the economy that a country's housing sector contributes to can vary, it is usually quite high. Therefore, you should keep an eye on important statistics about the housing market of the country whose currency you are trading.
Think for a second, when will you buy a house or start a major renovation of your apartment? When you have enough savings or expect a stable income, right? So, collectively, when home prices rise or home sales rise, common sense interprets this as a sign of strength in the economy. In addition, new housing projects employ a significant portion of the workforce, which could reduce unemployment and encourage central banks to raise interest rates.
As a result, when you see positive housing data, consider it bullish for a particular currency.
News Trading: Trading Strategies
News trading should be done strategically due to the need to react quickly in a volatile market. Traders have developed many ways to take advantage of the extreme volatility often seen when the actual outcome deviates from the expected consensus of market participants.
While such large and sharp price swings can lead to substantial and quick profits, they can also mean that large losses can also occur, so be sure to use a reasonable position size.
A number of strategies can be used to take advantage of exaggerated market movements. However, remember that news trading can be risky, very stressful, and not suitable for all traders.
Trading Hedged Positions
A hedged position is one in which the theoretical risk is reduced or absent. While not available to all traders, some traders may use a hedged position over a news release in which they are both long and short at the same time.
The hedge trader usually plans to make a profit on one section of the hedged position when the market fluctuates in his favor. They can then take a reduced loss or even a profit on another leg as the market pulls back.
Breakouts in the trading range
This strategy involves the trader identifying trading instruments that are in a range prior to a major release. When the news comes out, the trader watches for a range breakout and takes a position in the direction of the breakout once it is identified.
A trader using this strategy will typically place a stop loss within the previous trading range and set a take profit target roughly equal to the trading range width prior to the release of the news.
Buying Options
This strategy involves buying foreign exchange call and put options on the same currency pair on the same expiration date and can be a suitable strategy if the trader is fairly neutral with regard to market direction. This strategy can pay off well if significant market movement is seen after the news release.
Placing small orders
Some brokers automatically fill small orders for their clients at the trader's price despite the fast market trading conditions that can occur after significant news releases. This allows the news trader to place both a sell order below the market and a buy order above the market in a range close to the pre-market level.
If one of these orders is filled after the release of the news, the other order is canceled and the trader can exit their trade for profit if the market continues in the original direction after the release.
Also, the directional movement of the market after a release can sometimes be very strong, so an order can be filled at a level where the market is actually trading well above that level. This means that a trader can make a profit immediately after the execution by quickly closing their position before a pullback occurs.