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A Straddle Strategy for Trading the News
11/08/2013 9:00 am EST
Trading news announcements can be hazardous to your account’s health, but the staff at FXTM offers a strategy that can mitigate the risks.
Using sentiment to gauge the likely direction of a market during a news release and placing a trade in that direction as the report draws near is one good way of trading a news release when you have an idea how the market is going to move.
However, another method and one that requires no bias as to the likely direction, is to use a straddle strategy, whereby you place two orders on either side of the market just before the release is announced.
The principle behind this strategy is that news releases will often spike up or down strongly on a figure, giving enough volatility to profit from whichever direction the market takes. It’s for this reason that the straddle strategy works best on the most volatile news releases—central bank announcements, non-farm payrolls, and retail sales especially.
The Straddle Strategy
To better understand the concept of the straddle strategy, it is best to take a look at an example.
Let’s say, you are a GBP/USD trader and it is the first Friday of the month. Therefore, at 1330 GMT, the non-farm payrolls number will be released—a figure that we know causes significant volatility in forex markets with an average pip movement of around 100 pips.
To utilize the straddle strategy then, watch how GBP/USD trades over the 30 minutes before the announcement takes place. The highest price and the lowest price during this time will then act as your range. Just before the announcement place two orders—one, a couple of pips below the bottom of your range and one, a couple of pips above the top of your range.
When the news release comes out, the most likely scenario is that the market will spike up or down, taking out one of your orders and moving into a decent profit. You then have to make a quick decision as to whether to take the profit or hold out for a bit more. If you decide to hold out for a bit more, one option is to bring your stop down to lock in some profits.
Generally, you shouldn’t try to gain much more than half of the average pip movement associated with the release, so in this case be conservative and aim for around 40-50 pips.
On occasion, it is inevitable that you will get whipsawed with this strategy.
In other words, the market may spike, taking out your first order before reversing and taking out your second order, in effect cancelling your position for a loss. This is inevitable and will often occur when traders react to one element of a news release before realizing there is more to the data than meets the eye. For example, non-farm payrolls are often released with revisions to the previous month’s number. This number has been known to affect the market when it is radically different from what was previously reported.
However, there are two solutions to this problem. The first involves initiating a third order so that when your position is cancelled, it is then also reversed at the same time and you are back with a position in the direction of the market. Depending on the volatility of the news release, doing so will usually still result in a decent profit.
The second is to pay careful analysis to the news report itself. If you are able to analyze the information quickly enough, you can make a decision to close or open your trade depending on the figure. For example, if the news release is in line with expectations, the chances are the market may not move much. At which point, you could decide to simply close all orders and positions.
By the Staff at FXTM
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