The dangers of trading around news events when you’re a new trader and how to overcome them

Jan 21 • Between the lines • 1861 Views • Comments Off on The dangers of trading around news events when you’re a new trader and how to overcome them

shutterstock_126786311In several of our recent blog entries, when we’ve focused exclusively on trading methods, we’ve   highlighted the recent DJIA move on December 18th 2013 as a perfect example of a sudden and violent break to the upside as a consequence of a fundamental policy high impact news event.

Just a short re-cap;

The USA Fed, in the form of the Fed’s Open Market Committee, was closing its two day meeting and unexpectedly announced that it was tapering its quantitative easing programme by $10 billion in December. The main global indices then surged ahead and in some ways this surge was counter intuitive to that expected.

The majority of analysts (if cornered) would have suggested that the taper, taking monetary stimulus from the markets, would have led to a selloff in equities and perhaps a rise in the dollar versus its peers on the basis that, in simplistic terms, ‘less’ dollars would be created.

However, as often happens with market news, the initial news wasn’t what it seemed and upon closer investigation the taper wasn’t being ‘set in stone’, it was a tester and taster of what might come. In short the FOMC were testing the water and market reaction. They weren’t committing to a taper beyond this first experimental action. And given the time of year the ‘Santa rally’ was not going to be broken as very few institutional traders would be selling at a loss and risking their own and their department’s bonus figures. Now whilst we discuss the several points relating to this break to the upside it might be worth traders pulling up the daily chart of the DJIA…

Firstly, we can observe that if we were short (as part of a swing trading strategy) we should have been short since the beginning of December when the index broke to the downside. Price fell from circa 16,100 to approx. 15700 between December 2nd to December 17th. If traders weren’t vigilant then the violent break to the upside from the 18th could have taken out all the points’ profits the short trade had captured during the break to the downside.

Therefore we’d strongly suggest that traders (in order to prevent unnecessary losses) develop methods to insert the use of trailing stops, (or hard stops) into their overall trading methods as they formulate their trading strategies. If they’d had a trailing stop in place on December 18th then the stop would have moved in accordance with the trade development ensuring that, as price broke to the upside, the majority of our trader’s gains would have still been ‘locked in’.

Fix and adjust your stops every day when you swing trade

So the first observation we’d make is, that when you’re holding trades when a major news item or policy event is about to be released, traders must take a long hard and forensic look at where their stops are. And on a daily chart traders have a massive window to look for where their stop should be adjusted to.

Traders can use a Fibonacci retracement method to adjust their stop, perhaps plotting the top and bottom of the move each day and adjusting their stop to a circa 38.2% retracement. If the trade our trader is in retraces by 38.2% of the move, our stop would close out the trade leaving us theoretically (if we caught the bottom and top perfectly) with a circa 60% profit move. Alternatively our trader could use one of the many indicators to plot the placement of our trailing or hard stop. One popular method is to use the Bollinger bands; our trader could place their stops near to where price retraces to the middle Bollinger band, roughly the 20 simple moving average. Or our trader could use the PSAR as a point to adjust their stop each day.

As we’ve just outlined there are a variety of ways our trader could use a stop in order to trail price and traders would be best advised to experiment with them before committing to a method that they feel comfortable with and more importantly they must have absolute faith in their stop method. However, there are other methods our trader could use when a high impact news event is about to break in order to trade the news event…

Taking the day trade when a high impact news event has broken

Firstly, our trader could decide to (temporarily or otherwise) close their swing trade prior to the news release, after all being out of the market is in fact a position. Secondly they could add to the position once the news breaks.

What’s this? FXCC suggesting adding to positions, isn’t that one of the common recommendations and arguable misconceptions that their authors normally pour scorn on?

Yes and no, let us explain…

In several other articles we’ve gone to great lengths to explain how traders can trade the reaction to the news, rather than trade the actual news event. We’re fond of using the NFP number – the USA jobs number each month, as the perfect example. Regular readers of our blog might remember our suggestion.

Trading the reaction to the news and not the high impact news event

We suggest that our trader should wait for the first fifteen minute Heikin Ashi candle to close, immediately after the NFP news event, and then for our trader to enter the trade in the direction of the momentum as indicated by the candle.

For example, if the candle closed after the NFP number is full bodied, with an upward shadow, then the suggestion would be to take the trade in that direction, therefore we go long. The reverse would be applicable if the candle is bearish. Our suggestion is that this is strictly a 1:1 R:R trade.

Warning signal that should not be ignored

Now there’s a reason why we suggest a short term day trade may be in order, over and above taking a few pips or points based on this news release. If we’re short, as we would have been on many securities relating to the USA economy on December 18th, but the short term day-trade we’re presented with is very bullish, then we may be receiving a strong indication that our short swing/trend position is under threat. We may be witnessing price action developing, at its very origin, suggesting that a violent change in sentiment has just occurred.

Spreads and fills at times of huge high impact news events

There’s a cautionary tale to tell regarding trading news events, that all of us need reminding of at times. And it’s one of the reasons we have continually suggested trading the reaction to the news event and not the news event itself.

Traders trying to get into the market, during the time when news breaks, can sometimes experience market behaviour completely out of control of their normally excellent broker service. And there are times when you observe the market during such times and the only conclusion you can reach is that (temporarily) the market has lost sanity and is out of control.

The spreads can widen whilst spikes occur as the suppliers of quotes into the ECN broker model will alter their quotes significantly to ensure that they’re protected. Also traders can experience slight difficulty closing their trades, or opening new trades. As the volume of trades increases exponentially that activity can put intense pressure on the overall FX industry for a short period of time.

This lack of normal functionality is actually an indication of a market working effectively, but the randomness can often leave novice traders feeling let down and bemused. This is why experienced retail traders trade news events as we’ve outlined and don’t lay themselves open to levels of frustration that can lead them to doubt their method, or their broker unnecessarily.

These really are simple, positive suggestions and instructions that will serve new traders well and ensure that, new traders in particular, protect themselves and don’t fall foul of market behavior that is outside of the control of their broker. Market behavior which is very difficult to trade in, whatever your level of skill and experience.    
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