It’s not enough to only know technical analysis when you trade. It’s just as important to know what makes the forex market move.
Just like in the great Star Wars world, behind the trend lines, double tops, and head and shoulder patterns, there is a fundamental force behind these movements. This force is called the news!
To understand the importance of the news, imagine this scenario (purely fictional of course!)
Let’s say, on your nightly news, there is a report that the biggest software company that you have stock with just filed bankruptcy.
What’s the first thing you would do? How would your perception of this company change? How do you think other people’s perceptions of this company would change?
The obvious reaction would be that you would immediately sell off your shares. In fact, this is probably what just about everyone else who had any stake in that company would do.
The fact is that news affects the way we perceive and act on our trading decisions. It’s no different when it comes to trading currencies.
There is, however, a distinct difference with how news is handled in the stock market and the forex market.
Let’s go back to our example above and imagine that you heard that same report of the big software company filing bankruptcy, but let’s say you heard the report a day before it was actually announced in the news.
Naturally you would sell off all your shares, and as a result of you hearing the news a day earlier, you would make (save) more money than everyone else who heard it on their nightly news.
Sounds good for you right? Unfortunately this little trick is called INSIDER TRADING, and it would have you thrown in jail.
Martha Stewart did it and now she has a nice mug-shot to go along with her magazine covers.
In the stock market, when you hear news before everyone else it is illegal. In the forex market, it’s called FAIR GAME!
The earlier you hear or see the news, the better it is for your trading, and there is absolutely no penalty for it!
Add on some technology and the power of instant communication, and what you have is the latest and greatest (or not so greatest) news at the tip of your fingers.
This is great… Uhmmm… “news” for retail traders because it allows U.S. to react fairly quickly to the market’s speculations.
Big traders, small traders, husky traders, or skinny traders all have to depend on the same news to make the market move because if there wasn’t any news, the market would hardly move at all!
The news is important to the forex market because it’s the news that makes it move. Regardless of the technicals, news is the fuel that keeps the forex market going!
Be Careful Trading the News
Why trade the news?
The simple answer to that question is “To make more money!”
But in all seriousness, as we learned in the previous section, news is a very important part to the forex market because it has the potential to make it move!
When news comes out, especially important news that everyone is watching, you can almost expect to see some major movement. Your goal as a forex trader is to get on the right side of the move, but the fact that you know the market will most likely move somewhere makes it an opportunity definitely worth looking at.
Dangers of Trading the News
As with any trading strategy, there are always possible dangers that you should be aware of.
Here are some of those dangers:
Because the forex market is very volatile during important news events, many dealers widen the spread during these times. This increases trading costs and could hurt your bottom line.
You could also get “locked out” which means that your trade could be executed at the right time but may not show up in your trading station for a few minutes. This is bad for you because you won’t be able to make any adjustments if the trade moves against you!
Imagine thinking you didn’t get triggered, so you try to enter at market… then you realize that your original ordered got triggered! You’d be risking twice as much now!
You could also experience SLIPPAGE.
Slippage occurs when you wish to enter the market at a certain price, but due to the extreme volatility during these events, you actually get filled at a far different price.
Big market moves made by news events often don’t move in one direction. Often times the market may start off flying in one direction, only to be whipsawed back in the other direction. Trying to find the right direction can sometimes be a headache!
Profitable as it may be, trading the news isn’t as easy as beating Pipcrawler at Call of Duty. It will take tons of practice, practice and you guessed it… more practice!
Most importantly, you must ALWAYS have a plan in place. In the following lessons, we’ll give you some tips on how to trade news reports.
Which News Releases Should I Trade?
Before we even look at strategies for trading news events, we have to look at which news events are even worth trading.
Remember that we are trading the news because of its ability to increase volatility in the short term, so naturally we would like to only trade news that has the best forex market moving potential.
While the markets react to most economic news from various countries, the biggest movers and most watched news comes from the U.S.
The reason is that the U.S. has the largest economy in the world and the U.S. Dollar is the world’s reserve currency. This means that the U.S. Dollar is a participant in about 90% of all forex transactions, which makes U.S. news and data important to watch.
With that said, let’s take a look at some of the most volatile news for the U.S.
In addition to inflation reports and central bank talks, you should also pay attention to geo-political news such as war, natural disasters, political unrest, and elections. Although these may not have as big an impact as the other news, it’s still worth paying attention to them.
Also, keep an eye on moves in the stock market. There are times where sentiment in the equity markets will be the precursor to major moves in the forex market.
Now that we know which news events make the most moves, our next step is to determine which currency pairs are worth trading.
Because news can bring increased volatility in the forex market (and more trading opportunities), it is important that we trade currencies that are liquid. Liquid currency pairs give us a reassurance that our orders will be executed smoothly and without any “hiccups”.
Did you notice anything here?
That’s right! These are all major currency pairs!
Remember, because they have the most liquidity, majors pairs usually have the tightest spreads. Since spreads widen when news reports come out, it makes sense to stick with those pairs that have the tightest spreads to begin with.
Now that we know which news events and currency pairs to trade, let’s take a look at some approaches to trading the news.
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
Having directional bias means that you expect the market to move a certain direction once the news report is released. When looking for a trade opportunity in a certain direction, it is good to know what it is about news reports that will cause the market to move.
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. As we talked about in a previous lesson, this number will be different among various analysts, but in general there will be a common number that a majority of them agree on. 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.
This would also happen if the actual report released an unemployment rate of 10.0%. 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.
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 price will go up or down, hence the name non-directional bias.
How to Trade the News With a Directional Bias
Let’s now see how to trade the news with a directional bias in a trading scenario. Let’s go back to our example of the U.S. unemployment rate report. Earlier, we gave examples of what could happen if the report came in light with expectations, or slightly better. Let’s say there was a surprising drop. What effect could this have on the dollar? One thing that could happen is that the dollar falls. What??? Isn’t the dollar supposed to rise if the unemployment rate is dropping?
There could be a couple reasons why the dollar could still fall even though there are more people with jobs.
The first reason could be that the long-term and overall trend of the U.S. economy is still in a downward spiral. Remember that there are several fundamental factors that play into an economy’s strength or weakness. Although the unemployment rate dropped, it might not be a big enough catalyst for the big traders to start changing their perception of the dollar.
The second reason could be the reason for the unemployment rate drop. Perhaps it’s right after Thanksgiving during the holiday rush. During this time, many companies normally hire seasonal employees to keep up with the influx of Christmas shoppers. This increase in jobs may cause a short term drop in the unemployment rate, but it’s not at all indicative of the long term outlook on the U.S. economy.
A better way to get a more accurate measure of the unemployment situation would be to look at the number from last year and compare it to this year. This would allow you to see if the job market actually improved or not.
The important thing to remember is to always take a step back and look at the overall picture before making any quick decisions.
Now that you have that information in your head, it’s time to see how we can trade the news with a directional bias.
Let’s stick with our unemployment rate example to keep it simple. The first thing you would want to do before the report comes out is take a look at the trend of the unemployment rate to see if it has been increasing or decreasing. By looking at what has been happening in the past, you can prepare yourself for what might happen in the future.
Imagine that the unemployment rate has been steadily increasing. Six months ago it was at 1% and last month it topped out at 3%. You could now say with some confidence that jobs are decreasing and that there is a good possibility the unemployment rate will continue to rise.
Since you are expecting the unemployment rate to rise, you can now start preparing to go short on the dollar. This is your directional bias. Particularly, you feel like you could short USD/JPY.
Just before the unemployment rate is about to be announced, you could look at the price movement of USD/JPY at least 20 minutes prior and find the range of movement. Take note of the high and low that is made. This will become your breakout points.
*Note: The smaller the range the larger the tendency there is for a volatile move!
Since you have a bearish outlook on the dollar (your directional bias), you would pay particular attention to the lower breakout point of that range. You are expecting the dollar to drop, so a reasonable strategy would be to set an entry point a few pips below that level.
You could then set a stop just at the upper breakout point and set your .limit for the same amount of pips as the breakout point range
One of two things could happen at this point.
- If the unemployment rate drops then the dollar could rise. This would cause USD/JPY to rise and your trade would most likely not trigger. No harm no foul!
- Or if the news is as you expected and the unemployment rate rises, the dollar could drop (assuming the entire fundamental outlook on the dollar is already bearish).
This is good for you because you already set up a trade that was bearish on the dollar and now all you have to do is watch your trade unfold.
Later on, you see that your target gets hit. You just grabbed yourself a handful of pips! Booyeah!
The key to having a directional bias is that you must truly understand the concepts behind the news report that you plan to trade.
If you don’t understand what effect it can have on particular currencies, then you might get caught up in some bad setups. Luckily for you, we’ve got Pip Diddy and Forex Gump to help explain what effect each report can have on the forex market.
How to Trade the News Using the Straddle Trade Strategy
The first thing to consider is which news reports to trade. Earlier in this lesson we discussed the biggest moving news releases. Ideally you would want to only trade those reports because there is a high probability the market will make a big move after their release.
The next thing you should do is take a look at the range at least 20 minutes before the actual news release. The high of that range will be your upper breakout point, and the low of that range will be your lower breakout point. Note that the smaller the range is the more likely it is you will see a big move from the news report.
The breakout points will be your entry levels. This is where you want to set your orders. Your stops should be placed approximately 20 pips below and above the breakout points, and your initial targets should be about the same as the range of the breakout levels.
This is known as a straddle trade – you are looking to play BOTH sides of the trades, whichever trade it moves.
Now that you’re prepared to enter the market in either direction, all you have to do is wait for the news to come out. Sometimes you may get triggered in one direction only to find that you get stopped out because the price quickly reverses in the other direction. However, your other entry will get triggered and if that trade wins, you should recoup your initial losses and come out with a small profit.
A best case scenario would be that only one of your trades gets triggered and the price continues to move in your favor so that you don’t incur any losses. Either way, if done correctly you should still end up positive for the day.
One thing that makes a non-directional bias approach attractive is that it eliminates any emotions – you just want to profit when the move happens. This allows you take advantage of more trading opportunities, because you will be triggered either way.
There are many more strategies for trading the news, but the concepts mentioned in this lesson should always be part of your routine whenever you are working out an approach to taking advantage of news report movements.