In this article I will talk about a popular trend that is taking place among forex traders in terms of taking advantage of inefficiency in the markets during economic news releases. Although this strategy is a bit risky I have seen some of our clients reap great rewards by utilizing it.
How Economic Releases Work
Certain organizations like the Federal Reserve Bank announce economic reports such as the non-farm pay roll, GDP, Consumer price index and more. You will usually be able to find an economic calendar on the internet, in fact our website forexyourself.com has one available. Another very popular one is forexfactory.com. It has been historically tested that various economic releases will impact the price of the currency pairs that are associated with them. For example the Non-Farm Payroll will usually effect the U.S. dollar.
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A good economic calendar such as the one on ForexFactory states which currency pair will most likely be affected by a particular economic release. Although the long term price change of a particular currency pair is unpredictable, usually a short-term spike will take place. This spike is based on the divergence between the forecasted numbers (consensus) and the actual numbers released. Thus with this strategy a great deal of traders have created ways (which I will discuss later) to take advantage of the discrepancy between the consensus and the actual economic numbers.
For the most part there is a lag between when the economic information is released and the change in the price of a particular currency pair. It is because of this lag that many of our clients have been able to take advantage of this inefficiency. Usually only a limited number of agents of major news firms are allowed into the room where the economic numbers are released. After the release the agents must enter the data into news providing services such as Reuters or Bloomberg.
The key to success in terms of timing for the trader is getting into the trade before the spike begins. Prior to the announcement most of the smart money is backing away and not trading but as soon as the information hits they will trade. So what becomes important for the trader is the speed at which he can get his information. Therefore if a retail trader has a fast news feed and has software set up to provide him with the discrepancy between the consensus and the actual report, by being small and nimble he can get in as early as some of the professional banks.
For the most part, the banks are using the similar technology to some of the traders that are taking advantage of these situations. Now a lot of the dumber money are using slower news feeds and end up jumping on the spike later than players with these professional news services and end up driving the price up enough for the smart traders to get out of their positions.
Trading the Spike
In order to get in before the spike some technology is required. First you would need a fast data feed, and you can purchase Bloomberg or Reuters. Another option would be to sign up for a service that broadcasts signals during news. These types of services usually have numerous fast data feeds and broadcast buy and sell signals. These services are usually cheaper and easier to implement than actually paying thousands of dollars for the fast data feeds. The one drawback to these services is a lag due to broadcasting of the signal. The next step is to track the news consensus for the release that’s about to come out. Some good places to find the consensus numbers is Briefing.com or FXstreet.com or forexfactory.com.
Now you will need to do some historic research and analyze how the market has reacted to the difference between the consensus and the actual result historically. Basically for each release you need to know how large a discrepancy has to be in order for you to act on the trade one way or the other. This takes a lot of research or you can sign up for a news trade call service which already does the research for you. Now that you have your triggers set, I recommend making a calendar for yourself of the economic releases that you will trade and trading during your releases.
It is very important to get in as quickly as possible if your trigger is met in order to get execution. Once in a trade I recommend moving your stop loss to break even after you have gained 10-15 pips (this varies from trade to trade and trailing your position with a trailing stop after you have generated a profit or 15-20 pips. Having a profit turn into a loss is one of the most demoralizing things that can happen in trading and I recommend avoiding it at all costs if you are trading discretionarily. However you must keep in mind that stop losses are not guaranteed and it is very possible for you not to be triggered to exit at a stop level especially in a fast market such as the one during news trading. So it’s imperative that you watch your trade.
Since forex is an off exchange market usually the desks have to either take risk on a client’s position or offset with a bank. Since everybody is trading only in one direction during the spike it becomes hard for the forex FCM’s to offset the trades. Therefore they sometimes end up taking a hit during the news times. They do not like it at all, some will not allow news trading and some will re-quote or slip clients. One thing I recommend while trading with this approach is taking trades all the time and just slightly increase position size during the news trades.
I also recommend to let the FCM know what you plan on doing before hand so that they can tell you what size you can get away with. At forexyourself.com we have relationships established with many FCM’s and will be able to advise you on what you can do at each place. Also a very important thing to keep in mind is the smaller you trade during these releases the more likely you are to get execution.
GBPUSD 1/30/04 GDP spike.
GBPUSD 7/28/06 GDP spike.
Because this strategy can make money quickly a lot of people like to swing for the fences with it, for example leveraging out a large portion of their accounts on it. This is a huge mistake for many reasons. On main reason is the bigger you trade the harder it is to get execution at the trading platforms. Also unexpected events can happen and if you are leveraged out fully you can get yourself into a lot of trouble. I recommend using stops with this strategy and never risking over 5% of your account on any of the news trades. With some of the spikes that can be caught it is possible to make some very decent gains.
Post News Trades
A close friend of mine used to trade on the CBOT. He says that the only way he will trade the release is the pull back. Many times a spike will happen and the price will pull back allowing a second opportunity to get in. This is what’s called a post news trade. If the price spikes after the news and makes a slight pullback within 10 to 15 minutes it may be a good idea to get in with a fairly tight stop to catch the second leg of the move. Another way to trade some of the less volatile news announcements is a breakout strategy.
With this strategy you can take announcements regardless of the discrepancy wait until a range is created usually about 10 to 15 minutes and than take a trade in the direction of the range breakout. This is an effective way to capture 8-12 pips after the news trades. I recommend doing historical research or subscribing to a service that calls these trades out to determine your timing with precision.
By establishing a point A and B we are able to play the high probability break out trades. This is a trade we took on 9/29/06 USDCAD after the GDP announcement where we took 9 pips. Although this strategy has its drawbacks it allows the trader to get into some high probability trades. I recommend experimenting with different releases to see which one is a good fit. Please keep in mind that this strategy is risky since you are trading during extremely volatile times. Also it is critical to control your emotions and plan each trade with extreme precision.
Alexander Nekritin is a professional trader with
over 8 years of experience. His specialties include risk management and system
development. Alexander is the CEO of
www.forexyourself.com, which is a forex introducing broker and education
company that helps suite client’s needs in forex trading. Alexander has a degree
with a concentration in Investment Banking and derivative instruments from Babson College in Massachusetts.