How to Trade News

By understanding how it FITS into the narrative and your trading style

At the end of a week that was dominated by various news items, in a Trump era that has been characterized throughout by a series of significant news developments, it is perhaps time to address how one should trade news. Although we have dealt with different aspects of various news stories, we have not specifically and, indeed, generally tackled the much talked about (but little researched) subject of breaking news.

The week started with concerns over Italian politics, was punctuated by the ups and downs of the proposed Trump-Kim talks on June 12th (seemingly influenced by the May 21st ‘on hold’ US-China trade war news) but then diverted into possible US tariffs on German car exports and finished with a positive reaction to NFP – that was touted hours before unusually by a Trump tweet. All of these can be seen as market moving events, but only some could have been anticipated and therefore could arguably only have been traded after the fact.

The answer to the question ‘How do you trade news’ immediately conjures up images of a trader deciding to take a punt before a scheduled news event such as Friday’s NFP with a preconceived idea how the market will move on the release. Although there are many algos and HFTs (ie computerised trading programmes) that trade before during and after releases, most seasoned traders wouldn’t.

This is possibly a bad example, as our match to similar price action in 2016 not only projected an SPX rip but also a perhaps bizarre reaction early next week. Many seasoned traders would, in fact, wait until the market settled down after the release before taking a trade and only after they considered the fundamental, intermarket, technical and/or sentiment (FITS) implications of the news. Liquidity and possibly prices would be better.

“How Do You Trade News?” begs two further questions ‘what is news’ and ‘what is your trading style”. Today’s newsletter provides the background for further articles on the FITS approach to trading news items.

What is News?

A dictionary would define ‘news’ as a newly received report about noteworthy information that was not previously known. A trader would define ‘news’ more simply as something that could move the market. This, in turn, really does beg the question what moves markets – the subject of many volumes and years of research and only inconclusive outcomes.

As an academic exercise, clearly the theory one espouses most will determine the importance one attaches to a particular news event. A purely technical or even a chaos theory trader would presumably see news as insignificant or random, but the former may be confounded when the break of their chart point is unwound and the latter rejoice as the market returns to the pre-news level when the news is regarded as unimportant – a very common post news move. The DAX break to a further new low this week on the back of a potential US car tariff on German autos is a case in point. Exponents of the Efficient Market Hypothesis (Eugene Fama) would argue once the news is out, it will be fully discounted in the price and pretty immediately too. This clearly doesn’t happen.

Even attempts to factor in trader or investor irrationality such as in Adaptive Market Hypothesis (Andrew Lo) fail to recognise the variability of the news itself and its impact. The sequence of news for both Trump’s Tax and Dollar Policy would suggest a trader should go with the news announcement (even allowing for short term volatility which will be included in a future newsletter)

And yet if you traded Trump’s Tariff Announcement you would, at best, be confused if not in the red (sea of China).

The reasons why news doesn’t translate directly or sustainably into price the way many expect are several:

News is often inconclusive if not confusing. Breaking news will suggest but not guarantee a possible outcome. The number of Russiagate stories that led many prematurely to predict Donald Trump’s demise and a stock market crash are not worth repeating. And the long running North Korean saga has seen the impact, good or bad, decline and with greater speed. Anyone trying to trade to the Trade War based on policy statements must be having a rough time.

In a note today from Goldman Sachs it stated Trump’s policy has shifted substantially and “following trade announcements over the last few days, the trade war does not appear to be “on hold” but simply “on”, leaving even longtime observers of trade policy confused about the direction from here.”

Clearly a swallow doesn’t make a season even if it flies in and then out. Similarly, one economic release that points to higher economic growth will not be trusted (and therefore fully discounted) until there are further releases that support this increase. This lagging is typically reinforced by understandably conservative Central Bank actions and announcements, as they too seek confirmation particularly in a data dependent era.

News often belongs to a hierarchy of variables. The sustainability of the impact of news depends almost entirely on how it relates what is really driving the market. The stock market rallied throughout 2017 due to the expectation rather than realisation of inflationary growth. As a consequence, benign inflation reports did little to stop the rally, whereas Trump proposals that encouraged the expectation did. As this was and still is the sentiment driven part of the uptrend (which leaves fundamentals behind), news that affects expectations will have a much greater impact than economic releases that either confirm or deny the prevailing sentiment.

News is often interconnected to other variables. A news item may appear to be good or bad for a particular market (A) but its impact on a topically more important market (B) may lead to the opposite effect to expected on (A). The second half of 2017 saw the USD fall; most notably USDJPY amidst a stream of news that fueled expectations of inflation and the bond market’s decline. Although logic would have dictated a rise in the Dollar, it was the rotation out of US bonds and therefore Dollars that arguably had a greater impact. Similarly Friday’s NFP beat saw yields and USDJPY higher and yet stocks and particularly the NDX rally strongly in a predicted disconnect to the recent higher yield-stock down mantra. The news ie NFP had a variable impact.

Markets are a continuum. Few news events or economic releases can be regarded as isolated events either with regards to the narrative or other variables. The exception are black swan (surprise) events whose cause often appears isolated and explainable in hindsight only. However the knock on effects of black swans, even if transitory, are rarely isolated or limited to one market.

A news item or release forms part of an ongoing narrative or news trend. Trends generally rely on a stream of data or news that supports the reason for the move. In the early (also sentiment driven) stages of a trend reversal, the news may not support the direction the market is going but nevertheless the unwinding of positions continues to drive it further.

There are many technical traders who would support this view and rely on price action as opposed to lagging fundamental data as a guide to future direction. However where exclusively technical traders sometimes come unstuck is during the most aggressive phase where the data and news supports the trend providing it with breadth and often volatility that catches (quantitative eg RSI) technical traders out. This wrong positioning in the most aggressive fundamental phase frequently fuels the trend further and explains why, in some cases, news that appears to be against the trend causes only brief corrections that are soon bought (sold) as an opportunities to join the trend or exit bad positions. That was pretty much North Korea in 2017.

The market’s reaction to the news was telling us something that was borne out in the last quarter of 2017 and early 2018.

Something else was driving the market: sentiment and position-taking.

Understanding the nature of news and where it FITS within the narrative and the prevailing trend is the key to how one could trade it successfully. How one actually trades it depends on the time frame and style of the trader. Short term Amazon traders may rejoice at Donald Trump’s attacks, longer term buyers were either left bemused or rejoicing.

Whether a trader trades news events or not should depend largely on their trading style and their perspective (and context) at the time. Both will be the subject of future newsletters.

Here’s to making the very best.

Good Luck

Ed Matts
Matrix Trade

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