How to trade the news

In trading it is shouted from the rooftops, “trading is NOT for gamblers”. And it is absolutely true. Professional traders do NOT take punts; they have a clear set of rules that pinpoint high probability trades within a given strategy, and they happily walk away from the ‘table’ when those rules aren’t met. They abhor thrill seeking!

If however from time to time they were to take a trade in which the outcome was the same as a toss of a coin: 50/50; well surely then that is gambling? Entering a trade without a priori knowledge, and simply hoping it goes your way… Surely not! That smacks of rank amateurism!

Well, here’s the secret. For a growing army of end of day traders in pursuit of high reward trades, news trading consistently offers them that opportunity, even though they usually have no idea what the news release is! It’s not so much about content but the effect.

Significant news events happen throughout the month and the biggest is Non-Farm payroll. Its impact on price action is usually dramatic, and there is little to tell which way it is going to go. The usual rule of thumb is to stay out of the market on big news event days, or at the very least manage running trades with caution. The other approach, by those using larger time frame strategies, is to embrace it! This is not really possible on the smaller intra-day time frames where the smaller bars are more susceptible to the idiosyncratic movements of news events and can typically be spiked in and out of the trade before frustratingly seeing it head in the hoped for direction.

However for larger time frames, such as the daily bars, the opportunity to play the odds can be very rewarding. It’s all about reward to risk ratio. Big news events can, and often do, cause big swings with a single movement going several percent in one direction. If this goes in you favour of course it’s very rewarding, but predicting the direction is the difficult part. So the approach is not to try and predict the news, and therefore the resulting direction price will take. It’s simply not worth the effort. Just think about the reward to risk. It’s literally a toss of a coin as to which direction price will go but if you’re targeting a reward to risk of say between 3 and 6:1 then with a 50/50 win probability the rewards are going to heavily outweigh the losses. Below is a case in point:

 

CHFJPY before the news announcement

We had a sell order at the break of the low of the inside high test with our stop loss above the high and a target at the previous swing low.

 

The pay-off: CHFJPY after the news announcement

The news could have gone either way but this time it went in our favour. Just as well we did not set a limit order as the news caused this trade to run in excess of twice our target! This example demonstrates how we can really use news to reward us by keeping the reward potential high but the risk to a minimum.

So the rules here are that news trading must only be done where there is high reward potential with minimal risk, otherwise it’s a recipe for disaster. It can only be done on an end of day strategy where the larger daily bar has more chance of ‘soaking’ up the turbulence without getting spiked in and out before the big move. Don’t try and second guess the news or resulting direction, just focus on the technical, trading what you see with (and it can’t be overstated) maximum reward potential and minimum loss potential.