How to trade the Daily Trading Signals

by Pharaoh

Certain questions about how to interpret and trade the Daily Trading Signals come up over and over again in FPA’s forums. I’ve answered a lot of these at various times, but never put all the questions and answers in one place before.

News trading can make or lose a lot of money very quickly. If you don’t understand the terminology, you will be much more likely to lose.

First, you must understand the terms deviation, revision, and trigger.

For most news announcements, there is an expected number. This expectation is the average taken from a number of expert news analysts. The amount the actual number released differs from the expected number is called the deviation. If most of the experts agree on a very narrow range, then the pre-news market action usually won’t be as volatile, and reaction to a large deviation should be greater. If expert estimates are all over the place, then the market can get very jittery before the news comes out and reaction to the news can be much less predictable.

A revision is a recalculation of the previously released number. The monthly released number for employment, unemployment, consumer confidence, etc., is usually just a very good estimate. The next month, whatever group or agency released the data will update (revise) the prior number, usually at the same time they release the new one. Obviously, some numbers (like an Interest Rate Statement) are not subject to revision.

Large revisions can have very strange effects on the market. For example, if a county’s employment numbers were up by 20,000 last month and are up by 40,000 this month, that would show not only new employment, but solid growth in employment – this is usually good for a nation’s currency. If last months number is revised from 20,000 to 25,000, that would probably be considered even better. On the other hand, if last month’s number is revised down to 1000, traders could interpret this month’s numbers as so much better, or could lose confidence in the accuracy of this month’s numbers. If last month’s number was revised upward to 60,000, this would mean that more people are working (good!), but that this month’s numbers are actually a decline in the rate of job creation (bad!) and that the current release isn’t very trustworthy (confusing!). This at least partially explains some of the wild price swings when there is a large revision in the previous release.

Placing a trade is also called “pulling the trigger.” A news trigger is the minimum amount of deviation to make it worth placing a news trade. For example, the Daily Signals might say this month’s Canadian Beer Exports are expected at 3.2 million cases, and that there’s a 0.5 trigger. This means that a deviation of greater than 0.5 or less that negative 0.5 means you should place a trade. More directly, buy the CAD if production is 3.7 million cases or more, and sell the CAD if the number comes out at 2.7 million cases or less. The Daily Signals will tell you if you should be trading the USDCAD, AUDCAD, or some other pair for this specific report. (Disclaimer for the humor impaired – there is no monthly Canadian Beer Export report, but there should be!).

Depending on the currency pair, you might need to reverse the direction of your trade. For example, if there is a strong positive deviation in the quarterly Wool Production Report out of New Zealand (yes, this one is also a report I made up), you would expect the NZD to gain value when the report is released. This would mean buying the NZDUSD (or other NZDxxx pairs) or selling the AUDNZD (or other xxxNZD pairs). Similarly, reports that are good news for the USD mean to buy USDxxx or sell xxxUSD.

Just to really mess things up more, there are often multiple reports released at the same time. Usually, news traders will focus on only one report, but if other reports affecting the currency come out the other way, then price action can be unexpected. For example, one of the “Big 3” reports every month is US Core Retail Sales (also called Retail Sales ex-Auto). Since car sales are quite variable, it is simply the estimated amount of retails sales for the month excluding automobile sales. If the total Retail Sales deviates strongly in the opposite direction as Core Retail Sales, this can make price movement less predictable. The Retail Sales Report (which includes cars) is called the Headline Report, since it will be the one that newspapers (but not forex traders) will focus on.

There are many ways to place trades around news time. I will describe three of the most common, each based on a different time to place the trade:

Placing pending orders each way is called a straddle. People who do this usually place the pending orders about 3-5 minutes before the news is released. Stops and targets will vary quite a bit depending on the nature of the news report. The advantage of a straddle is that if there is solid movement in one direction, only one order triggers and (if the movement is far enough) your order closes with a nice profit. The risk of a straddle is that widening spreads and erratic price action can stop out in both orders.

You can try to get the news information and place a trade before most of the market has a chance to react. This is called spike trading. To do this, you need a fast internet connection, a way to get the news very quickly, and (if possible) a way to automatically place the trade depending on if the news deviation is big enough and in what direction the deviation is. There are companies you can buy news feeds from. There are several autoclicker software packages out there that can be used to partially or fully automate placing the trades. Or, you can get extremely fast news combined with automatic placement of your news trade orders in one package from Secret News Weapon.

The third common way to trade the news is to wait for the initial spike to happen, then try to catch price movement back towards the pre-news price (price action back towards the pre-news price is called retrace). Learning to trade the retrace is something you can do by watching and demo trading (do NOT trade real money while learning to do this) over a period of time. Also, many trading rooms such as Forex Diamonds try to trade the post-spike retrace.

Other news trading questions I’ve seen from time to time:

Where do the released news numbers come from?

Most of the numbers come from some government agency in the country that the news release is from. Some come from private groups.

What does m/m, q/q, and y/y mean?

Those are short for month to month, quarter to quarter, and year to year. Or, to put it more simply, these would mean monthly, quarterly, and yearly reports.

Why can’t the Daily Signals give entry price, target, and stoploss for news trades?

The Daily Trading Signals are issued many hours before the news comes out, so there’s no way to know what the price will be when the time comes to enter. Targets from entries are given if the trigger number is reached or exceeded and you can get in before the spike. Stoploss would be hard to give, since different brokers widen their spreads by different amounts. 25 pips might work great for one broker, but will get taken out by wider spreads at another.

What are basis points?

Interest rate changes can be described as fractions of a percent or as basis points. A 1/4% (or 0.25%) change can also be called a 25 basis points change.

Where can I see a list of news reports?

Every page in the FPA website has a top menu. Just click where it says Calendar. Currently, the calendar here is one of the fastest free calendars available, but it’s still not quite fast enough to do spike trading.

Remember, if you are just learning to trade the news, start with demo trading just to familiarize yourself with market reactions to news events. When you move to live trading, remember that slippage and requotes will be MUCH worse than demo trading, so only risk the smallest amounts of money at first. Please read my article about Risk Management if you have any questions about this. Also, if you don’t understand a particular trading signal, don’t trade it with real money. It’s much better to risk missing out on some profit than to risk throwing away your money on a misunderstanding.

I’d like to thank both Crazy Cat and Snow Man for their excellent suggestions and input on this article.

Source: The following FPA Forum Post.





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alan
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Saturday, July 26th, 2008 at 9:56 pm
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