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Forex News Trading

Trading the news is one of the oldest ways of making money in the forex market. In the old days, bank traders would have two telephones ready, one in their left hand for listening to the day’s breaking news and another in their right hand, reading to shoot out their orders to the interbank market as soon as the news hit the wires.

News trading can look very easy and simple to do in hindsight. NFP Jobs report came in on the low side? The US Dollar tanks. If you sold right after the report you would’ve been up 100 or 200 pips. Just looking at the charts it seems that all you need to do is be at the right place at the right time, just sell the Dollar and make a windfall of pips. However, reality is far from the ideal hindsight example. Trading any news event should be done with extreme caution and should ALWAYS involve an exit plan.

Trading large deviations from the forecast

In my other entry on the History of Retail Forex News Trading, I wrote about how the simple straddling technique is no longer effective. But if straddling is not an option, then how do you make money on news releases? One of the simpler ways you can make money around news releases is by trading the deviation from the median market forecast. In this day and age, with the large amount banks and other financial institutions invest in their research departments, significant deviations from the market forecasts are relatively rare, but they still occur. When they do, they present a unique opportunity to cash in on the risk repricing.

The Strategy

1. Step one, define which news are worth trading. Most economic releases either don’t cause a reaction in the market or are simply used as a catalyst to unload positions by large traders.

2. Define what is a ‘’significant’’ deviation from the forecast. Put a number on it to avoid subjectivity. Backtesting the news of choice will be instrumental in your success here.

3. Decide which direction to take after the news. The NFP came on the high side? Does this mean that the US Dollar will weaken on improved risk appetite or gain on increased odds for Federal Reserve tapering?

4. Forth, you need to select the currency pair to trade. This isn’t always as straightforward as it seems at first glance but more on this later.

5. At number five is choosing the right broker. As a direct consequence of the news straddling bonanza few years ago some retail forex brokers still place heavy restrictions around news releases. You need to find a broker that will allow you to place market orders immediately after news items hit the wires.

6. Consider the overall fundamental and technical picture. This is a somewhat more advanced topic that requires several years of experience following fundamental releases and the market’s reaction to news events. Let’s start from step one and work our way up to this one.

Step One: What news to trade?

You can’t trade any news release and expect to make money. Some fundamental releases are more important than others. A 20 percent deviation on the Non-Farm Payrolls report will carry more weight than a 60 percent miss on the Wholesale Inventories. How do you figure out which news events matter? Use freely available online forex calendars like the one at www.forexfactory.com/calendar.php for example. This site color codes news by importance. Red stands for high impact, orange for medium and yellow for low. Avoid all fundamental releases except red folder news. Here are some of the more important news you should to look out for.

Gross Domestic Product (GDP)

The preliminary estimate for the GDP is generally a good one to watch for most countries and currency pairs. The preliminary estimate is the first GDP estimate to be published and thus tends to have the highest market impact. The possibility for sizable deviations from the market forecast is also substantially higher with the preliminary GDP report.

Jobs Reports

The different jobs reports also tend to be good market movers. In the States, the most important job figures are published on the first Friday of every month (the famous Non-Farm Payroll report). In the UK, the jobs report with the most punch is the Claimant Count Change. This report measures the monthly change in the number of people claiming unemployment related benefits. In Germany, the most relevant jobs item is called the German Unemployment Change. The data measures the change in the number of unemployed people during the previous month.

Interest Rates

Interest rates surprises can be a major driving force behind forex moves. It’s not unusual to see instantaneous 100 to 200 pips moves when a central bank delivers an unexpected rate cut / hike. The poster child for interest rates surprises in the last two years has been the Reserve Bank of Australia. The RBA’s interest rate actions differed from the market forecast on three separate occasions in 2012 and once in 2013. Just as a comparison, that number for the European Central Bank is at zero for 2012 and one unexpected rate cut for 2013. While delivering a surprising rate decision just four times out of 24 may not seem like a lot, keep in mind that whenever this happens markets can move over a hundred pips making the wait worthwhile. In addition, if you’ve done all the needed backtesting work prior to the news event, you only need to be at your trading terminal for a few minutes around the scheduled report time. Investing five minutes of your time for a one in six chance of a major market move sounds like a good idea to me.

Consumer Price Inflation (CPI)

Inflation, especially consumer price inflation (CPI) is another important news event. Most central banks have a inflation mandate and a inflation target that they have to pursue. This means not allowing inflation to go up or down substantially from the target. In practice however most CBs are so afraid of the deflation boogieman that they will allow the CPI to breach the target on the high side but will rarely allow consumer prices to decline substantially. The latest example of this was the European Central Bank in November 2013.

The CPI is an odd beast for trading. As the impact of consumer price inflation figures on central bank policy tends to be skewed to one side, the report is not ideal for trading with the deviations method. In addition, the importance of this news item tends to fluctuate along with the economic cycle. For example, in the aftermath of the 2008 financial crisis, a lot of Central Banks were more willing to allow inflation in an attempt to ‘’paper over’’ the losses. With Quantitative Easing being the norm and inflation targeting falling by the wayside, the recent impact of most CPI reports was muted.

How to choose which news events to trade

While deviations between the market’s forecasts for interest rates, preliminary GDP, Jobs reports and the actual outcomes for these news items have produced large one sided moves in the past, there is no guarantee that these reports won’t go the way of the CPI and become unreliable to trade in the future. To prepare for this, always pay attention to the way the forex market reacts to news events. Aside from the ‘’Big Four’’ there are literally dozens of other fundamental releases with the potential to move the forex market. Here’s how you can pick out the best ones to trade.

Go to http://www.forexfactory.com/calendar.php again.

Now click on the filter button. You can find it in the upper right corner of the calendar as displayed on the picture above. In the Expected Impact box, deselect all options except red folder news items. In the currencies section, we ticked the AUD box. This will only display Australian news releases. As can be seen on the pic, for the week January 19th to the 25th the only major news report out of the island nation was the CPI. Now, click on the folder like icon next to the 0.8% CPI result. This will open up details on the last 15 Australian CPI reports. By clicking on the <More> button you can go even further back in the past. Data for past news goes back to January 2007.

Once you have this window open, you are ready to start the tedious process of backtesting. Open your forex trading platform, go back in your charts to the time of the CPI release and mark the market’s reaction to significant data surprises. Can you see a pattern developing? A CPI that substantially beats market forecasts should lift the Aussie. Rising consumer prices put pressure on Central Banks to act. The Bank then raises interest rates in a bid to cool the price increases. The higher rates make the country’s currency more attractive to hold, thereby increasing its value. The opposite situation develops when the CPI misses the mark. This should cause the currency to weaken. If AUD pairs fail to react in a predictable fashion, consider giving the news event a pass. Do the same for all the news you’re interested in trading. Also have a look at my other article on backtesting for tips on how to correctly perform this process.

Step Number Two: define what is a ‘’significant’’ deviation from the market forecast

The next step is defining what is a significant deviation from the forecast. Putting a number on this is recommended in order to avoid subjectivity. While performing the backtesting process mentioned in step one, make sure to write down how big of a deviation it took for the market to react in a predictable fashion. Always go for extra predictability here, not market movement. Large market players like hedge funds and banks will use the influx of volatility after important news events to unload their positions. Avoid the logical fallacy Post hoc ergo propter hoc. Don’t assume that because a price movement happened right after a fundamental release, that news caused the market move to occur. To avoid falling victim to this, always define how the market SHOULD react before starting the backtest. This ties in with step number 3.

Step Three: Decide which direction to take after the news

In this step, you need to decide which direction you will take after the release of the news. For example, say that you’re doing a backtest of the United Kingdom GDP. If UK’s GDP comes in substantially above forecast, the Pound should rally. If the currency fails to gain on the positive news a significant portion of the time, consider dropping the news from your watch list. Go for predictable, one sided moves. The NFP came on the high side? Does this mean that the US Dollar will weaken on improved risk appetite or gain on increased odds for Federal Reserve tapering? If after doing your backtest you can’t see a pattern developing, it’s time to find another news item to trade.

Step Four: Select which currency pair to trade

Selecting a suitable currency pair to trade isn’t always as easy as it might seem at first glance. Let’s use the example above with the NFP printing on the high side. Will the US Dollar lose value on improved risk appetite or rise on higher odds for Federal Reserve tapering? The knee-jerk newbie reaction is to buy the Dollar. How could more jobs ever be a bad thing for a country’s currency?

Well in this case buying the Dollar is not as straightforward. In the aftermath of the 2008 Financial Crisis, the US Federal Reserve lowered interest rates to near zero and kept them there for the past five years. This had the effect of turning the US Dollar into another funding currency, similarly to the Japanese Yen. As a slow recovery process started in 2009, the Greenback was sold aggressively along with the Yen, fueling the so called ‘’carry trade’’. The US currency has always been a risk off currency. After the Fed’s actions, it was also becoming one of the two major funding currencies of the world. Risk off / funding currencies tend to decline as the overall risk sentiment improves. A high NFP figure for the world’s largest economy has a positive effect on risk taking. As risk sentiment increases, the risk off currencies like the US Dollar and the Japanese Yen are sold off in exchange for higher yielding New Zealand / Australian Dollars.

A better and safer way to play the high NFP figures has been to short the Japanese Yen instead of going long the Dollar. The reason for this is simple, predictability. We already talked about the issue with a US Dollar long on better than expected data. The problem with going short instead is that sometimes the Job figures are perceived by market participants as so positive that they start to fuel increased bets for Federal Reserve tapering. The tapering process involves the slowing down of asset purchases with an end goal of removing the excess liquidity. The slower money printing has a positive effect on the USD. By avoiding US Dollar related pairs in the aftermath of NFP and instead focusing on the Yen, we still get to participate in any risk on rally but we’ll avoid being railroaded by a stronger Dollar. Good Yen related pairs with low spreads and high liquidity include the GBP/JPY (British Pound versus the Japanese Yen) and the EUR/JPY (Euro versus the Japanese Yen).

Step Number Five: Choosing the right broker

A good broker is essential for news trading. Many retail forex brokers still have heavy restrictions in place around news releases. Some will not allow the placing of orders within several minutes pre / post the news event. Others will raise the spread to unreasonable levels. Be careful when choosing a broker suitable for news trading. For this strategy, we need to find a broker that will allow the placing of market orders immediately after fundamental releases.

The best choice for this strategy are the so called ECN brokers. An ECN broker will immediately route your market order to the interbank and thus avoid the risk associated with the pooling of orders by Market Maker brokers. This type of broker doesn’t stand to gain if you lose and thus has no reason to prevent you from making money or delaying your execution. But how do you pick the right ECN broker?

The first requirement here should be low transaction costs. The cost should include both the spread and the commission. As spreads tend to spike somewhat during news time, even on ECNs (although to a lesser degree compared to MM brokers), the spread will end up being the major part of the cost. There are plenty of websites offering spread comparison tools. The two most useful ones are

http://www.myfxbook.com/forex-broker-spreads and http://www.fxintel.com/live

If you use Myfxbook you can see how a broker’s spread moved throughout the day. This will allow you to go back in time at the exact time of the news event and see the size of the spread. Here’s how you can do this. After going to http://www.myfxbook.com/forex-broker-spreads you’ll be presented with a choice of over 50 forex brokers to display spreads from and 10 of the major currency pairs. By clicking options in the top right corner you can modify which brokers / forex pairs to add / remove from the list. Just as an example we’ll use the EUR/USD currency pair. IC Markets consistently has one of the lowest spreads for this pair. By clicking on ICM’s EUR/USD spread you’ll be presented with the screen below.

As this snapshot was taken during the weekend, spreads are little higher than usual. You can also see how the bid / ask difference had a little spike as the weekend was drawing to a close. This pic displays only the last several hours of trading. To show more data, drag the slider on the bottom of the chart. After doing this, we can see that the average spread dropped from 0.3 pip to the more normal (for IC Markets) 0.1 pip. As Myfxbook will only allow you to go back in time for the last two days, you’ll need to check this resource right after a news event happens or the news’ spread will get overwritten by the new data. After expanding the data range, you’ll see why Myfxbook makes the process of choosing a forex news broker very easy. Small circles with the letter ‘’E’’ (for economic releases) are scattered all the way across the chart. These Es make it very easy to see how spreads moved during a particular news event.

As we can see on the chart above, EUR/USD spreads remained relatively stable throughout the last two days. One of the largest spread spikes happened on January 23rd with the release of the US Existing Home Sales figures. By clicking on the E that marks the spot of this news event, you can see the previous figures for the report, the market’s forecast and the actual result. Another click will take you to Myfxbook’s forex calendar, displaying even more data about the item. Repeat this process for several brokers that have the lowest EUR/USD spread (or the lowest spread for your forex pair of choice). Don’t assume that just because a broker has the lowest average spread it will also have the lowest spread during news time. This spread display will allow you to pick out the forex broker that has the lowest spread during your chosen news event without the need to download each broker’s trading platform and be glued to the screen for the news release. Don’t forget to include the broker’s commission on top of the spread to arrive at the total cost per trade. In our example above, IC Markets has a commission of 3.5$ per $100,000 lot, this will add 0.35 x 2 = 0.7 pip extra to the spread. For the US Existing Home Sales that saw spreads spike to 2.8 pips, the total cost per trade would be 3.5 pips.

Testing broker execution and slippage

The calculations above don’t account for market execution and slippage costs. As this strategy uses market orders to enter and exit the trade during an extremely volatile time, the effect of execution and slippage can mean the difference between losing or banking a profit. This is your next step. After you’ve chosen the forex broker with the lowest cost during a news event, it’s now time to put them to the test. Open an ECN account with the lowest deposit possible to test out the execution.

If you don’t have the stated account minimum on the broker’s website, it doesn’t hurt to talk to support and ask if they will allow you to make a smaller deposit. Most ECN accounts have a higher minimum deposit compared to regular accounts ranging from $500 to $1000. In many cases brokers will try to accommodate you and will allow a deposit small enough to cover the margin needed for your trade. However, keep in mind that most ECNs have a minimum lot of 0.1 (one minilot or 10,000 units) and offer a maximum leverage of 100 to 1. Thus, in order to trade 1 minilot on the EUR/USD at the current price of around 1.3700 you would need a minimum margin deposit of 137 US Dollars.

After making your deposit test out the broker’s execution by placing trades right after major news events. Record any slippage and execution problems. Having low cost per trade is useless if you can’t actually get a fill or if you’re repeatedly getting slipped on your trades. Remember that slippage on ECNs will be common in the direct aftermath of news events. The reason we chose to go with ECN over Market Maker accounts is that they (broadly speaking) guarantee the execution but not the market price. This means that if you place a long EUR/USD trade right after a high impact news event the broker will execute your order at the best price it can find on the interbank market, which can be very far away from the price you clicked on. MM brokers on the other hand will re-quote you to death during volatile times, making execution near impossible.

Step Six: Consider the overall technical and fundamental picture

This is an advanced topic that requires several years of experience in trading the market’s reaction to news events. The subjectivity of this approach means that this will be the hardest aspect of news trading to master. Was the Euro trading under significant selling pressure due to the Euro Crisis? If a currency pair in a significant downtrend any news events that cause the pair to go up will be seen as selling opportunities. The reverse is true for a currency pair in rally mode. Here, any down movement will be looked upon as an opportunity to get in cheap.

Is the AUD/USD trading close to parity or near a significant support / resistance level? Technicals can also affect how the market reacts to news events. Large traders will often place orders on price extremes, just beyond a significant support or resistance level. They do this because they know that there are large chunks of orders placed here, waiting for a break of significant resistance / support. They need the liquidity provided by these points to upload their large trading positions. Always try to remain cognizant of a significant S/R level. If a level has been thoroughly tested and is strong enough, the multitude of orders around it may stop anything but the most forceful market news reactions.

Investing | Forex | Fundamental Analysis


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