How to Trade By Taking Advantage of News Rather Than Letting News Take Advantage of You

For as long as I can remember the forex market has had a tendency to react (often overreact) to news. However, times have changed with liquidity providers (i.e. algos) replacing bank dealers as the main source of forex pricing, leaving the market without true market makers.

Market Makers vs. Liquidity Providers

What I mean by this is that interbank market makers had an obligation to provide two-way quotes under all conditions while modern-day liquidity providers can simply pull their bids or offers at the first whiff of volatility.

Add in news algos, which react to keywords without any regard to what the news means and you have a prescription for sudden, often sharp reactions to news.

Good Old Days Are Long Gone  

So, while in what I like to call the “good old days” you could count on bank dealers to interpret the news and decide whether the reaction was warranted. In current times, when algos provide the liquidity, you need to step back and let the dust settle before taking a stand if you feel the market has overreacted.

As Dennis Gartman wrote in Gartman’s 20 Trading Rules “Markets can remain illogical longer than we can remain solvent,” according to our good friend, Dr. A. Gary Shilling

As anyone currently trading in the forex market knows, this statement has become increasingly relevant in today’s world where a news reaction seems to have become a daily event.

So, how do you avoid getting caught wrong-footed on a news headline and how can you take advantage of it?

The reality is when there is a sudden spike or drop in a currency on a surprise news headline, it shows up as a straight line move on a chart. Remember, markets tend to move with an outsized reaction when there is a surprise in a news (e.g. economic data) release.

Take advantage of an opportunity

Have no position ahead of the news release. This is the prudent approach as many of us have seen how painful it can be to get caught on the wrong side when there is a surprise. It also allows you to trade with a clean slate and look for opportunities such as this chart shows:

Roll the dice

Position into the release and count on being lucky that there is no surprise that goes against your trade. For me, luck is not in my trading dictionary. You might as well bet in an online casino if you roll the dice on a news release. One risk here is that you double or triple up on an underwater position as you are already wedded to one side of the market. Once again, sometimes you can get lucky but other times arghhh!

Here is what I do to turn this into an opportunity

• I take a deep breath rather than letting emotions take over
• I evaluate the news and the subsequent reaction before deciding whether it is an overreaction or to go with the flow. .
• I look at my charts to see whether there are any key levels that I can use to trade or are potential targets to run stops.

The key here is to take a deep breath, avoid trading on emotion, and then decide whether to go with the reaction of patiently waiting for it to run out of steam.

To sum up, as retail traders we need to protect our downside, and this means capital preservation is needed so you can live to trade another day. Betting on a news release is gambling. Sometimes you will get lucky but that is not trading. I trade flat ahead of news and prefer to look for opportunities after the market beats itself up with a typical reaction.