Trade News with Caution (or Not at All)

02/23/2011 5:00 am EST

Focus: FOREX

Major news and data releases can cause big market swings, but can also defy the technicals and turn positions rapidly against you. One trader’s advice: Stay alert or simply stay out.

By Bradley Gareiss of GFTForex.com

I am a technical trader, and therefore, I don't place trades based on news announcements. My experiences with regard to these announcements have generally taught me the same lesson: stay away. I am referring only to major news announcements, as I don't really pay any attention to the smaller ones because they usually don't move the markets very much.

Below I will describe why I avoid trading during major news and various strategies for dealing with news announcements. Remember that I trade a very specific way, and I am not saying these announcements are not interpreted and used differently by others, but the below theories have proven useful when trading with geometric pattern recognition.

First off, I believe that news announcements are almost totally unpredictable. As you may know, there is usually a "forecast" and a "previous" number listed before the news announcement is made. The market's reaction is generally based on whether the actual announcement is higher or lower than the forecast. The problem is that this assumes all traders (or even most traders) react the same way to the relation between the actual number, the forecast, and the previous number. Even if we could correctly interpret this information, it is difficult to enter trades during these times because execution suffers within a fast-moving market.

In my opinion, these releases have very few long-term implications and are unpredictable in the short term. Of course, there are traders who may use these numbers to some degree of success, but I have never seen any strong evidence that you can profit while trading those numbers over the long term. Anyway, the one constant around major news announcements (such as the non-farm payrolls report) is that there are rapid moves with above-average magnitude. These moves can be very erratic. Sometimes the move is in one direction, and sometimes the move looks like it will be in one direction and then moves back to the starting point just as rapidly.

Furthermore, these moves can be very irrational. Not only do they often ignore the logic of the news announcement itself, but these moves often ignore the logic of the technical analysis we post. It would be much easier to trade these announcements if traders were rational, but they aren't.  Therefore, to me, the most useful aspect of these major announcements is the time when they take place. I check the timing of the announcements and avoid placing trades right before them.

If a pattern has almost completed, there is no advantage to placing a trade immediately before or after a news announcement. Let's say that this trade is a long opportunity. Let's also say that the pair is just above the entry. If this is the case and the news makes the pair shoot up, then we never entered and there would be no trade. If the news makes the pair shoot down, then we will likely be stopped out. Therefore, we never would take this trade.  

If the pattern is farther from completion, we still wait to enter until after the price action due to the news announcement has calmed down. If we have already entered a trade, we may close it before the news announcement comes out. This varies on a ton of different situations, which would be too long to write about in this article. For now, I could recommend coming up with theories on your own about this problem. At some point, I will probably write an entire article exclusively about that situation.

Now that I have talked about how to handle news announcements prior to having an open position, I want to cover how I handle an already open position when a major news announcement is approaching. There are probably some strategies where this exact plan wouldn't be ideal, however, this information should at least show the importance of having an idea about what to do with a position when there is a major news announcement upcoming. Also, keep in mind that only major news announcements are relevant for this matter. I would take no action if an announcement with low or moderate impact were on the horizon. Also, we only care about announcements that pertain to the specific currency pair in play. In other words, a big EUR announcement wouldn't make me alter my USD/JPY position.

Why do we need to worry about news announcements when we already have a position, and we already have our stop and profit target in place? We worry about this because a major news announcement can move the markets a great deal. Our examples below will show how these announcements can create more risk than normal.

NEXT: Three Trading Scenarios to Consider

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Case Studies in Trading the News

Scenario One: The Position Is Currently Not Profitable

In scenario one, we generally will leave the position on, but there is an exception to this rule. If the trade is 90% of the way to the stop (i.e. 50-pip stop and within five pips of stopping out), we will just close the trade. The reason for this is the concern that a big move against us could create a gap. If the gap goes past our stop, then we could lose more than we were willing to risk. Otherwise, we will leave the trade on and see what happens.

Scenario Two: The Trade Is at Breakeven

In this scenario, we generally will leave the position on, however, there are a couple of exceptions here as well. First, if you think there is a chance the news could gap beyond the stop, then get out.  This is rare, but could apply to short-term traders. Another reason to get out is if the original pattern no longer seems valid. If the original reason you put the trade on is gone, it makes no sense to stay in. This doesn't pertain to the FX360 methodology because the trades are well planned, but it could definitely happen with lesser-defined strategies. Hopefully this isn't common for you.

Scenario Three: The Position Is Currently Profitable

This is the most difficult of the three scenarios to handle. For the other scenarios, you generally leave your position on and hope the news reverses your fortunes and books you some profits. In the first scenario, the trade is more likely to be stopped out regardless, so at least you had a shot at a cheap win. Scenario two happens very infrequently, but scenario three is tricky. If the pair is 50% or more of the way to the target, I think it is best to just get out. The reason is that you could go from a near winner to being stopped out in an instant. However, there could also be some subjectivity in that level depending on how much you think the announcement could move the pair relative to the size of the pattern. The main thing is that you don't want to go from a near winner to a loser in a short amount of time. For me, this is more of a psychological philosophy, but it also is about risk/reward. You are risking a lot if you are 50%+ to the target for relatively little gain, and it would be based on a random news announcement that in some cases could neglect technical levels.

And risk/reward is what it is all about. A news announcement represents a move that is generally random, rapid, and large. Therefore, you have to ask yourself questions like "If I had a 50/50 chance of the pair moving up 30 pips or down 30 pips, would I take it right now?" That is a very basic example, but that is the general thinking behind the strategy I prefer to use. This is a gray area that I am sure will generate a lot of different thoughts. The easiest method is to ignore the news once you enter, but I think by following the criteria listed above, results will be improved when you have a position in the market with a major news announcement on the way.

By Bradley Gareiss of GFTForex.com

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