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The Challenge of Trading Forex News

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Written by H. Florentin "Lonewolf"

Wednesday, 06 July 2005

Anyone who has tried to trade the Forex Markets during economic news announcements knows how dangerous this can be. Although not all news moves the forex markets economic news often cause violent gyrations in the currencies it is perceived to impact. Many a beginning trader has suffered severe losses during this time, often beyond recovery. The temptation of trading news, either before, during, or shortly after announcements is due to the extreme volatility occurring during this time. It is a time characterized by high risk and high reward. Because the forex markets are global and only "sleep" from 4 PM Friday EDT to 2PM Sunday EDT, news announcements take place at many different hours of the trading day during the course of a given week. Planned news announcements from various geographic regions impact different currency pairs to varying degrees. Forex traders should therefore have easy access to a weekly calendar of anticipated economic news announcements so that they are prepared for sudden movements in the currencies they are trading. Many traders stay out of the forex market until long after news is announced and even wait until the following day to take a position. Due to the volatility of a news-driven market, however, opportunities to profit from the impact of news can be difficult to ignore. Traders who take on the challenge of trading the news then should develop well thought out strategies for mitigating risk and enhancing the probability of profiting from this exciting market time.

Trading Before Economic News

Trading a currency pair immediately before an economic news announcement is little more than a gamble, and is not sound trading practice. This is since economic news, even if correctly anticipated, may result in a reaction entirely different from what is expected due to market interpretation of the news. For example "good" news could cause a currency to decline in value merely because the market considers that the good news has already been discounted by the market, and is already "built into" the price. Conversely, "bad" news may cause the value of a currency to increase in a relief rally if the news is perceived as less negative than expected. In addition, economic news is often interpreted in the context of other factors, including important political and social events whose weight and impact can be difficult to predict. It is therefore best to be flat immediately proceeding news.

Trading Shortly after Economic News

Even traders that are out of the market before news are often hurt by attempting to trade a currency pair shortly or immediately after a news announcement. The moments following news are often a veritable minefield of price swings, jerks, and head fakes. This is since many traders are taking positions very tentatively and often exit or reverse their positions within seconds if the market moves against them. In addition the worldwide interpretation of market participants may vary considerably. It is this "tug of war" between market players of varying size that results in extreme volatility. Often prices will appear to move in one direction, only to abruptly reverse and move in the opposite direction. It is at this time that many traders attempt to sense the direction of an extended market move and enter the move early. Trading shortly after news is arguably almost as uncertain and dangerous as trading immediately before news. The outcome of trades attempted during this time is also highly subject to the whims of chance.

Trading After Market Stability

For traders with the patience to wait for greater market stability and certainty there are frequently two possibilities for trading the news: trading the trend or trading the reversal of a significant or extreme price movement. A safer opportunity to profit from news announcements in the forex market is to patiently wait until there is "resolution" of direction on the part of a currency pair. This usually occurs within minutes of the initial reaction to news, though not always. If the price of a currency begins to trend for example, traders may seek an entry point on a temporary reversal in order to profit from a longer move. For this strategy, traders should focus on nearby support and resistance points. Trendlines should also be drawn in order to be alert to trendline breaks and to enable a better assessment of the probability of continuation of movement in the same direction. Whether entering long or short, it is important not to "chase" momentum movements, but rather to enter carefully at an advantageous price point.

Though trend trading after resolution of price movement can be profitable, often reactions to news will cause movements to occur so quickly that a safe entry in the direction of momentum is risky and subject to reversal. In this case traders may have little choice but to wait for the move to play out completely. Reactions to news announcements, when finally played out, often result in extreme net price movements of 100 - 150 pips. Such moves often have a high probability of reversal to a degree suitable for a profitable trade. That is, an extreme intra-day drop in price is likely to "bounce" while an extreme intra-day rise in price is likely to pull back in part due to profit taking. Sudden, violent market movements are particularly subject to reversal. Trading the reversal of an extreme price movement is often highly profitable provided entry is made close to the reversal. Calling "tops" and "bottoms" is never easy, but with a patient, cautious entry using conservative size, a successful trade is more likely to result. Once again resistance and support points (including Fibonacci support and resistance points) as indicated on the chart are helpful in determining the reversal, as are trendlines. Stops should be in place in case the market moves against the position.

Conclusion

It is said that impatience is a trader's greatest enemy. This is certainly the case in relation to trading the forex markets during news announcements. It is a small wonder that many forex traders avoid trading news all together. But for those who dare, it is far better to do so with some knowledge of market behavior during news announcements and a strategy that might provide an edge in dealing with powerful market forces.

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