How Is My Trading Influenced by the News?

I had an interesting chat recently with a subscriber about the current ‘financial meltdown’, which addressed two main areas of conversation that I felt would be worth sharing via my website and newsletter.

What are my thoughts on the financial crisis, and how do I trade the news or allow news to influence my trading?

The fact is that, although I do follow the major financial news and while the current financial crisis is fascinating, my trading is almost exclusively based on price action.

I’m not an economist, so I’m not interested in money supply, inflation rates, GDP, interest rates and trade balances. I’m not a financial analyst, so I’m not too concerned with company balance sheets, profit and loss statements or P/E ratios. These fundamentals don’t concern me.

So you’ll typically find very little in the way of market commentary, economic or fundamental analysis from me through either my website or my newsletter.

While I do have an opinion on the current state of the US and global economies and who is to blame, and am amazed at what I perceive to be gross mismanagement of the situation so far, there’s little to be gained by sharing that. After all, it’s just my opinion based on the commentary I’ve read so far and it’s quite likely biased by my own beliefs and perceptions. My assessment of the situation is of little relevance to anyone else. If you’re after opinion, there’s no shortage of market commentators willing to provide it.

So rather than share my thoughts on this, I’d prefer to see you conduct your own research and come up with your own opinions.

I guess the benchmark I would like to apply to my website & newsletter content is, ‘Can this material add value to your trading business?’ If not, I don’t plan on sharing it.

So, onto the more important questions that I believe can add value to your trading business – do I trade the news, or allow news to influence my trading?

Let me address this in two ways. Firstly, how do I deal with news in a ‘normal’ market environment? And secondly, how do I alter my trading when the whole market is gripped by uncertainty as we’re experiencing with the current financial crisis?

As a short-timeframe technical trader I am largely unconcerned with the longer term fundamentals. However I am interested in the main news releases, as follows:

a)     the regular economic data releases such as Non-Farm Payroll figures, Retail Sales figures and Interest Rate Statements; and

b)    the major ‘non-regular’ news items, such as the recent House of Representatives meeting to consider the bailout bill.

 

Why am I interested in these news releases? Simply because they are capable of producing significant volatility and leading to large moves in the markets.

About 12 to 24 months ago there seemed to be an explosion, especially in the forex world, of trading strategies designed to capitalize on the volatility produced by these news releases, typically related in some way to straddling the market with stop entry buy and sell orders, in order to enter long or short and profit regardless of which way the market moves. Unfortunately these people look at the charts in hindsight and only see the potential profits. They fail to adequately address the risk that comes through trading these events, through platforms freezing, huge slippage or requotes. And even when they get a good fill, often the volatility leads to rapid directional changes, stopping out one or both trades at a loss.

There are other ways to trade news events. Kathy Lien and Boris Schlossberg currently provide a signals service with very impressive results and a realistic approach to the forex markets, based on a combination of both fundamental and technical analysis.

For me though, neither approach works.

My focus with these news events is simply as it relates to risk management. How can the potential volatility increase the risk of my position?

So for example, if I’m trading GBP/USD on the first Friday of the month and the Non-Farm Payroll figures are due out, I’m not concerned with the figure that is released. What concerns me is simply WHEN is the report due and is there potential for a volatile move?

Let’s say I’m again trading GBP/USD and the British CPI figures are due out at today, what concerns me is not the CPI figure, but simply WHEN the report is due and whether or not there is potential for a volatile move?

One more example, let’s say I’m trading the emini Dow and the Fed Chairman Ben Bernanke is speaking somewhere today. You can probably guess now what it is I’m interested in. That’s right – not what he’s saying, but simply WHEN he’s saying it and is there potential for volatility?

So this raises several questions – how do I know what news is coming up, how do I know the potential impact on the market and what do I do about it?

How do you remain aware of what news is coming up? Simply track down an economic calendar. Many brokers provide them, as do some news sites. One of my favorites is available through the Forex Factory site, currently at http://www.forexfactory.com/calendar.php . If you don’t trade Forex, don’t worry about it. The impact of Non-Farm Payroll for example isn’t felt just in forex. It’s just a great calendar – very easy to use, with the ability to list a whole week at a time and to change the timezone to whatever region you wish (click on the current time display).

How do I assess the likely or potential impact of this news on the market? Well, if you use the Forex Factory calendar then you’ve been provided with a good starting point. Their people have done much of the work for you, and already classified the news releases as:

• RED – high impact
• ORANGE – medium impact
• YELLOW – low impact

 

I encourage you to do your own analysis and research as well. Sometimes you may disagree with the assessment of impact and wish to apply more caution to a YELLOW or ORANGE release. But generally I think they get it close to 100% right.

And how do I use this information?

If a setup triggers within a couple of minutes prior to a RED news release, I’ll just pass on that trade. In my opinion the potential for a volatile move within the next few minutes in either direction, simply makes the trade a gamble. I’ll wait for the next setup.

If I’m in a trade as we approach a RED release and sitting on or around breakeven or with a loss, then I’ll exit. If I’m sitting on a nice profit then I’ll usually tighten up the stop beyond the closest swing high/low and ride it out. Often I’ll be stopped out and possibly incur some slippage, but on occasion the move is in one direction and the profits will increase significantly. If I’m sitting on a good profit, I’m happy to take that chance. Yes, it’s a gamble, but it’s one I’m often willing to take.

For ORANGE news, I won’t pass on a trade, but will simply manage it more closely. There is less likelihood of slippage, but the market may change direction. So I’m happy to enter a trade prior to an ORANGE release and I’m happy to ride out an existing trade. I will pause though before the release to confirm that my stops are in a technically correct position in the event of a change of market direction. Essentially there’s little change to the way I trade, but I do so with a heightened awareness of risk.

YELLOW news – I am simply aware of it, but I make no changes to my normal way of operating.

For daytraders, it’s essential that you’re aware of any factors that can affect your position. If you don’t already have a favorite economic calendar, try the one provided by Forex Factory.

For swing or position traders, the short term impact of news releases will be of less concern to you; however you should still be aware of the major ones due to their potential to change trends.

Consider as well whether there are other fundamental factors that could impact your chosen market. For example, stock traders also need to be aware of other key events such as earnings reports and ex-dividend days.

The important thing as a technical trader is to not just trade in a vacuum completely unaware of the world around you. You don’t need to have an economics degree. Just be aware of what external factors may impact on your market and then manage risk appropriately.

Now, to the second major theme of the article – how does news influence my trading when the whole market is gripped by uncertainty and fear?

The decline in the equity markets that occurred last week (6-10 Oct 08) is unlike anything I have ever seen before. Friday was unbelievable – seeing the Dow drop 350 points from the open and then rally just under 600 points all in the first 15 minutes – that’s incredible movement and great potential for profit. But don’t forget though that with this increased profit potential also comes increased risk of loss. The volatility levels are through the roof and that can work both ways – don’t allow the opportunity to blind you to the risk.

My focus is always on risk management first. I’m a firm believer that if I manage the risk then the profits will take care of themselves. So with the markets offering increased risk, I made some corresponding adjustments to my execution in order to reduce that risk back to more comfortable levels. This means that potential profits are also reduced. So what! Slow and steady wins the race. I’d prefer to be hitting singles than swinging for the home runs.

What changes did I make as volatility increased?

• In late September I reduced my position size by half. In my personal approach I like to trade with two parts to the trade, each with a different profit target. So the options I have are to reduce both parts by half, or to simply trade one of the halves. This time I just simply dropped the second part and traded part one only, with the closer target, but also allowing it the opportunity for removal of the target and implementation of a trailing stop if I felt the potential for a trending move. This approach was chosen due to my perception that the choppiness would lend itself better to closer targets. (NB. I actually haven’t tracked results for a ‘Part 2’ position during this same timeframe, although that would have been a smart thing to do to be able to confirm my decision). In any case, what this action resulted in was a sudden 50% decrease in position size with a corresponding decrease in risk.
• Mid-way through the first week of October I reduced timeframe, dropping my lowest ‘execution’ timeframe from the 2 min chart down to a 233 tick chart. During the waterfall decline week of 6-10 October, the timeframe was further reduced to 122 ticks. Increased volatility had meant that I was missing too many trades due to the stop being uncomfortably wide. Dropping timeframe meant that I could continue to trade my strategy with smaller stops thereby maintaining the same risk level. The only other option would have been to widen my stops and simultaneously further reduce position size in order to maintain the same dollar risk level.
• By Thursday 9 Oct 08, I took that further step – widening the stop and decreasing the position size. Lucky too – I had a tough day on Friday which would have been much worse had I kept the stops at their normal size.

So basically there are several options for dealing with increased volatility. I chose different options at different times, but used a combination of the following:

1. Reduce position size
2. Widen stops (but only with a corresponding reduction in position size)
3. Reduce timeframe
4. Pass on trades that required too much risk for my position size

 

But there are other options as well:

1. Trade selected setups only, if they’re better suited to the volatile markets
2. And of course, often the best advice of all but very difficult to take – take a vacation.

 

It all comes down to managing risk. Your number one priority is to survive to trade another day. Trade well through managing risk to ensure you emerge from the financial crisis with your account still intact. Reducing risk may not lead to the big retirement trade, but it decreases the likelihood of you being taken out of the game entirely – a key factor in ensuring long term success.

Hopefully this discussion has prompted some of you to consider how you should be handling the extreme volatility that comes from fear in the markets. The big talk in the markets right now (late Mon 13 Oct 08) is that the bottom is in and we’ve started the recovery rally. Sure, we’ve had a large up move, but I have some serious doubts that we’ve seen the last of the bear market. There’s great opportunity ahead. Just be sure to not forget the risk.

Happy trading,

Lance Beggs

 

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