Shares Magazine
August 31 2006
Responding to the news is more difficult than it may seem, says Marilyn McDonald. If you’re going to do it, make sure you understand how the currency market works and have the discipline to get it right.
There seems to be a lot of hype around trading fundamental news in the forex market lately. In my opinion this is due to two reasons: a) a number of brokers have decided to stop allowing trading during news, and b) a number of people touting trading the news as the best way of making money in forex seems to be growing.
Let me expound on (b) just a little to roll my eyes… I have now read the 1,000th article by some so-called guru selling something (usually a newsletter or signals) that essentially states, “Timing your trades in the forex market can be difficult. But if you look at the fundamental news announcements you will see these large potentials for gain.” There is usually an accompanying chart complete with a lovely arrow at the time of the news announcement, a couple of huge candles immediately after the lovely green arrow, and quite often in big letters “Over 100 Pips!!”.
It is so easy to look at a historical chart and point out buy and sell points. It looks impressive. And to those who don’t understand the dangers and pitfalls lying ahead it looks like a no-brainer. Why would you trade at any other time when there is all this fabulous money to be made during news announcements?
My first nugget of advice is please, please don’t trade the news. It takes a lot of experience, nerves of steel, and quite a lot of discipline. It is not for everyone and certainly not for those who don’t fully understand all the ramifications of news trading. Rather, you should be aware of the news, put your time into knowing how the market affects your chosen currency pair(s), and understand how the numbers in each news report relate to its market price and movements.
The Market
The currency market is faster and more volatile than any other market out there but, during high volatility times, such as news announcements, it can perform unbelievable feats. Generally called ‘fast market’ by most brokres, these high-volatility times can bring wild swings in the currency prices, enormous price gaps, widening spreads and millions of transactions happening all at the same time.
My definition of a price gap is when the price of a currency pair either jumps or falls from its last bid/ask quote to a new quote, never trading at the prices in between these two prices. When this happens, both stop-loss and entry stop orders will either be executed at their requested rate (if the market happened to trade there) or at the next recorded price in the market. This is an important point that we will come back to later in this article.
In these instances both stop-loss and entry stop orders will either be executed at their requested rate, if the market has traded there, or at the next recorded price in the market, regardless of order size.
The standard industry practice for most currency dealers (including dealers in the interbank market) during fast market conditions, is to set market levels and execute orders manually without the use of automated systems or services. During fast markets the pricess is generally as follows;
- Initially, major money centre banks and other online price providers halt all direct dealing and thier pricing engines are suspended.
- Currency dealers analyse the event and determine the correct price.
- Prices enter market 20 to 30 pips wide or more.
- Spreads in market narrow as more currency dealers enter the market.
During a fast market event there are typically delays in trade execution, which may be significant, while rates are cross-referenced to ensure valid execution. Further, stops placed close to a market that has traded through the stop price, can be repriced on the next best tradable price. Thereby, a specified rate order does not provide a fixed-price guarantee to te news trader or broker.
The Players
Now that we have identified how the market works in fast market conditions, let’s look at the traders who typically trade in this game. Most people I see trading the news fall into one of three categories:
- The Quick Clicker subscribes to a good, fast news service and trades just after the news announcement has been released and (hopefully) before the market has had time to react.
- The Strategist straddles the market hoping to catch the move no matter which direction it moves.
- The Wait and See waits for the dust to settle and tries to catch the retracements.
Each of these traders faces different and no less dangerous pitfalls.
The Quick Clicker
The Quick Clicker usually spends the big bucks for a fast, reliable data feed (or has a good compilation of RSS feeds and an RSS feed reader). This trader waits for the actual announcement with the mouse between the buy and the sell buttons, generally knows what the consensus numbers are, has read all the analysis and has alread decided which way to trade depending on the actual release numbers.
Quick Clickers face a number of dangers, lagging execution being one of the most talked about. If you follow this method and your broker allows market orders you will be filled at the next available price. This means you may be filled at a price substantially different from the one on the screen when you clicked the button. In one case, about three years ago, there was a 50 pip gap during a US Non-Farm Payroll announcement. If your broker is not a market maker you may also see a widening of spreads right at the announcement time so, while your pair may only have a two pip spread in normal market condition, you may have to cover eight, ten or more pips before your trade is profitable. Fortunately (or not) the market tends to move extremely quickly during these times so you may quickly cover the difference or alternately show a resounding loss that much sooner.
Quick Clickers and Strategists also face other ramifications from banks and brokers alike. This is commonly regerred to as flagging. Traders who consistently trade large lots for short time periods during new times, run the risk of additional ‘interference’ from the banks. Callaed scalping, trading this way on a consistent basis is frowned upon. Traders should trade during non-news times as well as news times and try to hold their trader for longer periods. Gaining redemption after being flagged is not always easy to do and can cause you problems down the road.
The Strategist
The Strategist’s concepts seem logical. Place a buy limit (complete with stop losses) and a sell limit (also complete with stop losses). The issue here has to do with market volatility and widening spreads. For example, let’s say the bid of the EURUS is at 1.2867 with a spread of 2. You place a buy limit at 1.2880 with a stop loss at 1.2865 and a sell limit at 1.2857 with a stop loss of 15.
A currency pair can whipsaw wildly when an announcement happens. In a matter of a few minutes the pair can bounce around like a water droplet on a hot pan. So the market jumps up to 1.2889 where you get filled, remember buy limits may not hold and you might get filled at the next available price. It then bounces straight back down. To be fair, let’s say it trades at your stop-loss price and you only lose 24 pips. It can continue straight down and trigger your sell at 1.2857. We will be nice and fill at that price even though that may or may not happen in real life.
We will also assume that you get out where you want, only losing an additional 15 pips. So, in the space of sections you have lost 39 pips. Suddenly your grand idea looks more like a guaranteed way to get completely whipsawed and drop your account balance. We didn’t even factor in the widening of the spreads. If the spreads move from 2 to 10, your pending orders and stop losses will be executed that much more quickly.
The Wait and See
The Wait and See tends to avoid the bulk of the stress and hassle tied to fasst market conditions. They wait for the dust to settle a bit and then try to catch a little profit when the pair is on it’s way back from where it came, whether it is over the course of minutes or days. Because they get in after the market has progressed through the bulk of the fast market behaviour, thier trades are generally executed fairly quickly, though they may experience some slippage and slower execution speeds than normal market conditions. The Wait and See trader also runs the risk that the currency pair will not retrace at all but find a new support level where it ended up.
Wrapping Up
So now you know the dangers of trading the news. If you are determined to trade the news, I suggest that you have sufficient funds in your account before you place any trade, getting caught in a margin call during news announcements just adds insult to injury. Also, be aware that your market order executions may be significantly different from the price you get quoted during market fluctations. And finally, educate yourself as much as you can on your currency pair, its behaviour during news and how different announcements can affect your pair. Forewarned is forearmed. Happy trading!