Fads come and go in trading all the time. One of the majors fads to come and almost go in recent times is news trading the forex market. I thought I might pen down some thoughts on the area of news trading.

The Lure of News Trading

Without exception, all large market players use economic release information as a way of making decisions about their positions with currencies, bonds, equities, etc. The constant flux of economic releases as like the lifeblood of the financial world as every small snippet of economic data is used by traders to adjust their expectations around how the central banks may or may not act in the future.

Given the centrality of economic data to making trading decisions, trading the news presents a huge lure for beginner and experienced trader alike. During the release of an economic indicator it is not uncommon for the currency market to move 100 pips or more. With this kind of volatility, a trader in theory who has “mastered” news trading can potentially make a staggering profit in the space of seconds or minutes. What is even more interesting is the trader does not need to sit at the screen for hours. They can sit down half an hour before the release, prepare themselves and be finished trading within the hour.

The News Trading Industry

Based on the lure of quick money, news trading has become a very grubby industry. It always has been and always will be. If you talk to old timer futures traders who have been in the game more than 20 years, they will tell you that the phone boards of their brokers would light up during news releases. It was a blood bath, with everyone trying to screw every one else.

About the only thing that has changed is now on top of that we have mum and dad retail traders dropping their retirement funds into the markets and every shark, charlatan and marketing spin doctor is vying for a cut of that cash in addition to the other traders. These charlatans have you believe that new trading is easy money and they charge extortionate fees to let you access their “secrets”; then within a matter of seconds your retirement funds are gone after your first bad trade.

News Trading Methods

Contrary to the marketing hype, there are no news trading secrets. There are only four ways to trade the news:

• Straddling
• Trading the spike
• Fading the initial spike
• Trading the longer term trend

Straddling works by placing conditional orders above and below the market just prior to a news release and then is either coupled with a trailing stop or preset profit targets and stops based on historical market data. For a long time this was the way a small number of retail traders in the know made money hand over fist in the forex market. Eventually a number of bucket shop forex brokers realized they were loosing money to these traders. The problem was that your average bucket shops are allowing you to trade a synthetic market they have constructed themselves based on prices they can get from the institutional interbank market. The bucket shop was opening themselves to unusual amounts of risk as they were allowing their retail traders to take on positions that you could never get filled in the real market. In order to lower their risk profile a number of brokers started rejecting conditional orders placed just before news releases. A number of other brokers also got rid of their trailing stop facility.

With limitations being placed on conditional orders and trailing stops, straddling ceased being an effective form of trading. The next step in regaining their edge was for news traders to trade the initial spike. News traders did this by looking at historical data around news releases and if the economic result was more than about a standard deviation away from its expected value then they went long or short, depending on how far away from the expected value it was. Initially doing this was like shooting fish in a barrel. At about the same time a number of online chat groups started to form and skilled traders (for an extortionate fee) would share their entries and exits at the time of the news release. The influx of so many news made news trading become extremely competitive and it eventually came down to who had the fastest news feed and the fastest trigger finger. A number of traders coughed up the couple a grand a month to get the fastest news feed on the planet – Bloomberg and Reuters (Bloomberg and Reuters are the fastest because they have financial reporters actually in the lock up – other news feeds just repeat data they pull off of Bloomberg and Reuters).

By this time the retail brokers were loosing even larger amounts of money on trades that in the ordinary interbank forex market would not even be possible because an institutional trader would never be able to get such trades filled. The reaction by FXCM and a number of other brokers was to identify traders who were news trading and stopped them from placing orders electronically and demanded that orders are only manually placed over the phone. This only stemmed the flow of trades from the old hands, but it could not stem the flow of trades from the ever growing crowds of newbie traders. To get past the issue the bucket shops had to introduce dynamic spreads which automatically widened to an extra ordinary large number of pips just prior to a news release. The retail forex market is now starting to behave more like the interbank market where liquidity around news events is scarce and cannot support large numbers of news traders and as a result the price spikes.

For a very long time retail forex trading was sold on fixed spreads. Different companies sold their services based on how low their fixed spread was. With armies of newbie news traders at the gates, they could no longer keep their fixed spreads. As a result of forex news trading nearly every retail forex brokers now uses dynamic spreads and the days of trailing stops are almost long gone.

Some traders moved on to trading the aftermath and tried to fade the spike in the hope of catching the reversal after the initial reaction. Like catching a falling knife (or a falling price with a huge spread) this tactic was never as reliable as trading the spike or as straddling and has never really caught on.

Now that the retail market has caught up with the interbank market, finally retail traders are starting to mature in their approach to trading forex markets and are starting to act more like institutional traders. Institutional traders do not trade the initial spike in the news release. The reality is they are obsessed with interest rates and more importantly their expectations around interest rates as it helps them adjust their positions. If the economic indicator indicates that the expectations around future rates is misplaced, many institutions will adjust their positions accordingly. You will see them starting to play in the market in the 20 minutes to 3 hours after the announcement as the trend starts to form around adjusted expectations. To get an idea of how these traders do this, you should have a look at the “Inside the Banks” webinar over at forexmentor.com. It is well worth coughing up the couple of hundred dollars to see how the institutional traders do this.

Next Article

In my next article I will look at some news trading myths.

This entry was posted on Monday, May 5th, 2008 at 10:38 am and is filed under News Trading. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.