David Song, FXCM

Question:

Are there special forex strategies for trading news events?

Response:

There are a few strategies that come to mind when trading news events. However, finding the style that fits one’s trading personality and tailoring it to meet different needs can help to curb the risk for loss while broadening the scope to profit from market volatility. Some strategies involve setting up entry orders ahead of the event risk, while others are dependent on mathematical calculations, but all require some degree of prudence and flexibility given the inconsistency in market reaction. At times, the best move can be to stand aside when traders show a muted reaction to the news or when the market turns choppy.

As a result, there isn’t a special strategy when trading news events. Although, there are a few steps currency traders can implement to take advantage of the market volatility that materializes following the release. When the news crosses the wires, there tends to be either a sharp spike in one direction or a mixed reaction to the data, depending on how the outcome stands up against market expectations. More times than not, it will be difficult to discern whether the initial reaction will continue to gather pace as global investors weigh the implications of the data. Often, the best thing to do when in doubt is to wait for confirmation in order to avoid ending up on the wrong side of the market. As a result, letting the noise clear should help currency traders to get a better sense of where prices are headed. Beyond that, looking at the reaction in smaller time frames can provide a clearer signal of whether or not to trade the event.

Depending on your level of comfort, timeframes ranging from 5 to 15 minutes can help to identify the strength behind the initial reaction, while using the closing price as confirmation can assist currency traders to catch the market reaction before it gets exhausted.  For example, the Bank of England decides to raise the benchmark interest rate by 25bp, which sparks a bullish reaction in the British Pound. As the GBP/USD advances, we want to see the prices on a 5 to 15 minute chart close higher, and get a sense of how much the exchange rate has moved relative to the market volatility prior to the news release. Gauging the swing highs and lows preceding the reaction can offer a good proxy of where a realistic stop and target could lie. Keeping up with the GBP/USD example, let’s say that the exchange rate was trading at 1.6100 just ahead of the BoE rate decision. The pair marked a swing high of 1.6130 prior to the interest rate announcement, but bounced back from a swing low of 1.6070. We would then incorporate the price developments into our trade and place the stop 30pips lower, while the limit would stand 30pips higher from the entry if we were to pull the trigger on a long GBP/USD position. As most news events tend to have a limit impact on medium to longer term price action, setting realistic targets and stops should help to increase the number of winning trades.

At the same time, traders should implement a high degree of prudence when using leverage as market reactions following news events tend to be inconsistent. Rather than loading up on a big position, I prefer to trade two small-sized lots in an effort to test the waters. For both lots, I set a reasonable stop, but like to keep an open target for one of the positions in order to maximize the possible gains from the trade. If price action moves in our favor and takes out the limit for the first trade, I move the stop on the remaining position to cost, and usually let it run until it comes up against a critical price level. Indeed, there are times when I end up on the wrong side of the market, but have found that these steps works well with the way I trade. In turn, finding the strategy that fits your trading personality and tailoring these basic steps to meet your needs should help to increase the likelihood of catching a profitable trade.

David Song, Currency Strategist at DailyFX.com

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