How to trade the news in Forex trading
All Forex traders have tried to trade the news at some point, because that’s when the big price moves happen.
And the big price moves are where the big money's made… right?
What amateur news traders fail to realise is that the more obvious an opportunity is, the more dangerous it is.
The truth about Forex news trading is that it’s a lot more complex than what people think.
In theory, one can make big profits trading the news. But in practice, it’s much more likely for one to lose a lot of money doing so.
If you’re not discouraged by this, read on to learn how you can make news trading work for you.
News releases to trade
Economic news releases are categorised into 3 types: high impact, medium impact and low impact.
For most purposes, you’ll only want to trade high impact news and ignore the others.
High impact news to consider trading are those relating to:
- Interest rates
- Gross Domestic Product (GDP)
- Inflation (CPI)
- Consumption (Consumer confidence)
- Purchasing Managers' Index (PMI)
- Home sales
- Retail sales
The most important news release is the US Non Farm Employment change report that details the employment situation in United States. This particular news release is well known to cause exceptional volatility in the currency market.
How NOT to trade the news
One of the most popular (and ineffective) ways that amateurs trade the news is by straddling the market before the news release.
Here’s how it works in theory:
First, wait for the market to start ranging running up to the news release.
Before the news release, set a pending order to buy above the range, and a pending order to sell below the range
The idea behind this approach is to catch a move in either direction upon the news release. The moment one of the pending orders are triggered, the other (non-triggered) order is deleted.
Again, this is all in theory where everything sounds nice and dandy.
In reality though, here’s what happens:
In this situation, the pending buy order would be triggered, then the market turns around and heads right for your stop loss.
Here’s another example on the same currency pair, just one month earlier:
Trading news breakouts is expensive
The problem is not just about an unpredictable move upon a high-impact news release.
The other thing to consider is slippage and a widening of spreads during the news event.
Typically, Forex brokers will widen spreads a few seconds before the news release, which can sometimes be enough to trigger your entry and stop loss immediately. This can often result in an instant loss even before the market price reacts to the news.
Fxkeys has written a good roundup post about this point here: 4 lies about news trading
How to trade the news: News anticipation
Now that I’ve explained the dangers of trading news releases, let’s now take a look at two approaches that you can safely use trade the news.
The first approach is to trade the run up to the news event. This involves entering a trade days or even weeks before the news is scheduled to be released.
With this approach, you’ll identify what the majority of traders expect the outcome of the news event to be, and then trade in that direction.
- For example, the US Federal Reserve was widely expected to raise interest rates on 17 December 2015. This was big deal back then.
At the time, most people had expected the Fed to raise interest rates. But I also knew that there was a small but reasonable chance that the Fed might postpone that decision.
I was more certain of people expecting an interest rate hike than I was of the Fed actually doing it, so I decided to trade the expectation, not the news itself.
Later on, the Federal Reserve indeed announced a rate hike, but a strange thing happened: the USD didn’t rally and fell instead!
This brings up yet another danger of trading news events: even if you correctly guess the news result, the market reaction will not always follow in a predictable (or logical) manner.
Thankfully, since I was trading the news expectation and not the news itself, I got out of the market before the release.
This is often termed as “buy the rumour, sell the fact”.
How to trade the news: News over-extension
The second way to trade the news is to fade a price over-extension upon the release.
As emotional creatures, people are prone to overreacting to news surprises, even if the deviation is relatively insignificant.
This characteristic is exaggerated on the chart when liquidity is low (during news announcements), causing market prices to overshoot.
After the news is released, liquidity floods back in to the market and the price surge becomes unsustainable.
An opportunity now arises for news traders who are looking to fade the initial price surge.
News Fading Example
On 19 February 2016, the US CPI surprised to the upside with a 0% release versus the forecast of -0.1%.
At the time, everyone was already expecting the CPI to remain low, so even though there was a deviation of +0.1%, there was no material difference to the general outlook of the US economy.
Despite this, there was a small but rapid surge of EUR/USD selling, and I managed to scalp 7 pips by fading that move.
When fading the news, you should be looking for a profit of anywhere between 5 - 25 pips, depending on the prevailing market sentiment, and the magnitude of the release deviation.
News trading isn’t for newbies
As you might have noticed, both news trading approaches require some understanding of the ongoing market sentiment, which is something you can only develop with time and experience.
It’s easy for anyone to simply tell you to “straddle the news”. But the truth is, if it was really that simple then there would many more news traders than there currently are out there.
Yes, news trading CAN be profitable. But the conditions that lead to regular news trading profits don’t show up all that often. If anything, news trading is more a supplementary trading approach than anything else.
- If you’re a beginner trader, I wouldn’t recommend news trading to you at all.
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