Such as the Trade War and Brexit
This week finished with the US-China trade discussions and Brexit machinations hanging over the market. As commentators and therefore traders believe these key geopolitical issues will trigger significant movement for 2019 and we will soon see some sort of resolution, this week’s newsletter addresses how to analyse such potential news and in particular consequently how to trade volatility before during and after these events.
The more preparation we can do before an event, the more effectively we can react without emotion.
News comes in essentially three different forms.
Scheduled events such as economic releases and statements or press conferences from central bank meetings which are subject to countless pages of analysis before and after the event. Although this seems to heighten expectation, their impact varies according to expectation and context.
Unexpected News – In an increasingly dynamic world subject to economic and geopolitical uncertainty, the number of unexpected news flashes (eg Trump Tweets) seems to grow, prompting a knee jerk reaction. It is perhaps surprising but the vast majority of such flashes do not have a lasting effect.
Unscheduled (anticipated) events are where the market is expecting an event or statement that is not precisely timed. Many of the news flashes concerning the Trade War and Brexit fall into this category where their imprecise timing appears to add the initial impact, ie short term volatility, even if the effect is not lasting.
Clearly the extent to which a News event is expected affects our ability to prepare and yet how we should analyse the event and trade is not that different.
News is subject to the same FITS (fundamental, intermarket, technical and sentiment) pillars of analysis that we deploy for any instrument in any time frame. And to get the right answer, that is how to trade volatile events, we have to ask the right questions.
Fundamental What is at stake? What is the context? What are the key drivers to that fundamental outcome? How will it impact the markets, given the context, and therefore what are the key instruments?
Intermarket How will a particular move in key instruments how affect other markets? And are they likely to accentuate or curtail volatility in the key instruments ie positive or negative feedback loops?
Technical Are there any particular set ups (including event fractals) in any markets that tip an outcome and are there any trigger points (breaks) that indicate whether a move will be sustained or not as a result of an outcome and how far (targets)?
Sentiment To what extent is the market positioned into the event, do they have a bias about what trades after ie momentum or fade? How long are they (or new entrants) likely to hold the positions and where will they exit? Are there any useful templates that suggest the extent of any move? What volatility can we expect as a result of market sentiment and trades?
In this respect, we are very fortunate the markets have a habit of reacting in a similar fashion under similar conditions. Gold’s consistent performance on NFP is remarkable and more a question of extent of the spike down before the recovery. This consistent reaction typical of many markets to many releases isn’t perhaps so surprising as the fact that number of variables aren’t as great as it seems. New outcomes are generally positive or very positive, inconclusive or mixed and negative or very negative and consequent trading decisions can largely be distilled to buy, sell, hold or stay out.
In some cases, the underlying conditions and sentiment into a news release can actually tip the outcome and subsequent reaction. USDJPY traded like a beat into the most recent NFP and ramped on the actual release that greatly exceeded expectations.
Although AUDUSD broke technical levels and got the market bullish going into the last RBA meeting, it actually (and probably consequently) followed the same pattern it has done on average under Lowe.
Once we identified trading opportunities whatever edge we are using into the news release we can formulate a trading strategy.
The analysis into any event should essentially be similar in approach to any other time where the FITS analysis helps determine a trade that should be subject to similar risk/return parameter. And yet because the probability of a market reaching a target before a stop is lower in a news event due to increased volatility, this reduces our Matrix (effectively the likelihood of success) and therefore suggests a smaller position size. This will also help maintain emotional control and discipline. As is anticipating the unexpected.
The impact of a news event will vary depending on its significance to the predominant narratives and drivers, other forthcoming scheduled events that may curtail a market reaction (eg NFP coming 42.5 hours after FOMC), markets actual and real expectation (price movement into a release tends to alter real expectations away from the consensus) and how different the market reacts to what was expected ie shock value.
Markets frequently react differently to what was expected, for four reasons.
News is often inconclusive. For example, a strong NFP number can be discounted by a fall in average earnings or a rise in the unemployment rate. It is also interconnected, the inability of the bond yields to sustain a recovery after the last NFP beat held both the Dollar and Stock Indices back. And sometimes there are too many one way positions to allow the market to react as it should. In other words they were already long and therefore could only take profit. Markets are in a continuum and any news release must be regarded as only one part of an ongoing narrative which has encouraged traders already to have positions and may be subject to a later change ie uncertainty. This is evident from the typical EURUSD reaction to news events since 2007 where the rate of movement in the first 24 hours after the release is greater than the 72 hours following the event.
How one trades an event does differ depending on the context and the time horizons of a trader. But the overall approach should be the same—to tread carefully.
And once the dust has settled and the significance of the release can be seen as part of a broader context or extending trend, then that will help determine the next trade or strategy for the next event within a continued news stream.
Over the next few weeks we aim to signal more shorter term trades particularly with respect to increased volatility over the Trade War and Brexit. Qute a few of these prospective trades, we know already.
And yet, as traders, we need to stay flexible.
Here’s to making the very best.
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