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Trading Strategy: News Trading

Trading the News
Written by Andy

The trading strategy called ‘trading the news’ seems so obvious that you wonder why everyone doesn’t do it. The ability to leverage with CFDs means you can use them to potentially magnify returns when there are spikes in a market. But if you decide to trade the news, you would do well to pay attention to some basic principles when you try this CFD strategy as this approach can be high risk as markets can move substantially leading to large losses as well as gains. From Bloomberg and the FT to MarketWatch and the Investor’s Chronicle, keeping abreast of the latest financial happening can definitely help you react more effectively to CFD trading opportunities that arise. Monitoring news flow is important as it can have a big impact on the value of existing investments and may also highlight new opportunities. Whether you pick up the paper versions themselves or visit the websites, what matters is that you are approaching the CFD markets with an awareness of the activities and upcoming events that may affect them.

Trading the news is often mentioned in connection with Forex markets, and this is because it is easy to get news from different countries that will affect the way they are viewed, however in practice big economic announcements can trigger reactions across a broad sweep of markets. Typically, this would include inflation rates, unemployment figures, price indices, government interest rate decisions, and other factors. The release of all these details is usually scheduled months in advance, so you have a good warning of when to expect the news. For instance, the USA non-farm payrolls numbers released by the USA Bureau of Labour Statistics on the first Friday of every month are watched carefully by event-driven traders as this serves as a health barometer for the USA economy and the report release may lead to violent price swings. Beware also of the importance of the American markets as they have a big influence over what happens in other markets; in particular a good or negative start in London could reverse in response to news originating from the USA. Traders with open positions have to keep this scenario in mind as well as the unpredictability of the markets to such announcements.

For instance when we had FOMC statement and the bank stress results were announced I awaited with a baited breath as the news was released on a Friday about 18.00pm and for about 30mins the markets didn’t really react but then they took off. The problem with trading news like this is stops; your normal stop is not going to cut it in volatile conditions, say the euro for arguments sake took off and gained 100pts on a 5min candle, in reality you would need a 100pt stop to trade it, most people who fail to trade the news get stopped and then the market moves the way they were anticipating, hence trading these times is very dangerous, especially when a speech is going to happen afterwards.

The Stock Markets: The Discounting Effect

The stock markets always respond to important happenings in one way or another although a market’s reaction to newsflow is never easy to predict. If the occurrence was predicted, the impact on the actual event date will already have been discounted in the markets and the effects will be minor. In market market predictions are known to adjust prices long before the happening actually takes place. One of the most convenient ways to avoid getting caught out by surprise is to utilise a forward calendar to check when the next scheduled company announcement is due to take place. Of course if the event is of sudden nature and comes out as a surprise, the market will react sharply (example: when the World Trade Center (WTC) was destroyed in September 11, 2001 by terrorist attacks).

This important insight has many applications today. For instance, granted, there are still sovereign debt problems out there. But to what extent is the market prepared to possible repercussions? Most analysts recognize the PIIGS problem. This could imply that the default danger is already partially factored into current prices. Furthermore, double-dip debates are constant in the media. A sudden downturn wouldn’t be fully unexpected.

In 2008, such triggers were far less predictable – who would have predicted the collapse of AIG, Lehman Brothers, and Bear Stearns!? The initial rejection of TARP also threw Wall Street a curve ball. So, I would say that while there are certainly black swans lurking on the horizon now, I have a feeling that the impact of another downturn in the markets won’t be as large as 2008. The really dangerous black swans are unpredictable evens, such as a major economy suffering a debt downgrade or an expanded war in the Middle East. These happenings might very well catch Wall Street off guard and lead to major troubles. But for more predictable events, too many market participants are simply playing it safe and are wary of a possible double-dip. This expectation could cushion an abrupt correction.

It’s better to be proactive and trade in anticipation of economic news – otherwise it’s like catching a train after it’s left the station.

CFDs: Trading the News

You can also trade CFDs on shares based on company news, such as earnings reports and dividends announcements, and these will be expected in advance. Some company news, such as CEO appointments or retirements, may not be scheduled, but you don’t need to trade if you have no prior warning.

Many traders and investors like to trade stocks following news releases. ‘We tend to see activity in individual stocks that have just announced their results or there has been a news story about,’. ‘The days leading up to company’s result will usually prompt a rise in trading volumes as traders scour analyst and press forecasts about how the business is performing.’

Economic data which is explicitly related to a company’s operations is also a catalyst for trading. For example, increased oil futures might lead to buying of BP shares.

By studying the movement of the markets, you can learn which announcements have a significant effect on share prices or currency exchange, and which can be ignored in the context of expected volatility. Where you can be caught out, however, is when you take the news at its face value, and trade accordingly. Knowing how much money a company made in the last year is useful but, as we all know, past performance is no guarantee of future earnings. Keep in mind that things are not always as expected and no one knows for sure what tomorrow’s news will contain.

Do keep in mind that a great profit report does not necessarily deliver a higher share price. This is because, theoretically at least, the stock market is highly efficient and as such a share’s price is likely to incorporate not only the current market forces but also future expectations and performance. If a company or indeed an entire industry is expected to perform well in six months time, the stock market won’t wait six months to send the share price up. It will build the future profitability into today’s price. As a general rule – unless a company releases a particularly strong trading update, it’s share price is likely to fall. Shares that reach all-time highs just before the announcement of a trading update are an example of this phenomenon. The expectation of a good trading update is already built in to the share price and as more and more buying occurs the share can get a little ahead of itself. This is especially true if the share price has had strong growth prior to the report.

The discounting effect mentioned above doesn’t only apply to enterprises either. For instance, say that the news was that unemployment had fallen dramatically, you may think that would help the country’s currency. This is not necessarily the case. The markets tend to include information even before its release, usually based on expectations, and if unemployment was expected to reduce anyway the currency may finish up weaker after the announcement. It is far from easy to predict just where the market sympathies lie. In fact some sharp traders sometimes even take a contrarian view speculating that the news is already fully factored in.

Of course, a profit downgrade will typically lead to a fall in share price… Management will try to work out forecasts as accurate as possible, but the unexpected can, and often does, happen. Another problem with trading the news is that there are many professional traders who have very fast newsfeeds and the greatest experience, and they can trade the news more quickly than you. This can mean that the major part of the market move has been captured by them before you can place your trade.

One tip is to watch the trading activity as the time of the news release approaches. The quieter the trading before release, the more the news is anticipated and, possibly, the greater the effect of the announcement. Certainly, to trade the news you need to be ready at your terminal, as the effects may only last a few seconds or minutes, and you need to be in and out of your trades in that time. You have to be particularly quick if you’re looking to trade on an unexpected event such as the Japanese tsunami as price swings can happen within 15 to 20 minutes. Trading the news in this respect is a CFD trading strategy that is more suited for day trading than any other form of short term trading.

Despite these cautions, if large moves are expected it is worth trying to capture them. One way is to place two special orders, one each side of the normal trading range, so that you enter the market only in the direction that the security is moving. If the price goes up, the buy stop order is triggered and you buy the share; if the price goes down, a sell stop order will get you into a short position from which you can profit.

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