Essential Aspects of Trading the News
What to Be Aware Of When Trading Currencies Around News Releases
Some of the most volatile forex trading activity that you will encounter will be right before and right after the release of important economic indicators. In the window of just a few minutes, there can be exchange rate moves as big as 100 pips or more, meaning that there is massive potential for profit and loss.
Keep in mind that this manner of daytrading is inherently very risky, so if the strategy that you are using is based on 'position trading' or 'swing trading' (having your trades open for days or even weeks at a time), then trading the news is probably not for you.
You should know by now that there are a handful of significant economic indicators that most of the big banks and institutional investors (as well as the army of individual forex traders) rely on to determine the strength of a given currency. These are the indicators that give information about the most important aspects of a country's economy, such as inflation (given by the Consumer Price Index or CPI), the labor market (given by non-farm payroll and unemployment data), and trade balance (the ratio of imports to exports).
There are two important concepts that you must understand if you are even thinking about trading around news releases: Price slippage or skipping, and also the typical manner in which prices fluctuate in the first hour after a news release. Price slippage is important to understand, and it is something that has probably caused many premature wrinkles on the faces of forex traders.
Within one minute after important economic data is released, these are the times where there are the highest amounts of trading activity and the biggest price moves. Knowing this, the concept of price slippage is easy to understand:
Most forex trading platforms have very fast order execution, meaning that once you click on the 'buy' or 'sell' button your order will be filled within one or two seconds. During normal market trading conditions (most of the day when there is no important news releases), market prices will update on a pip-by-pip basis, meaning that you will see the price change from 1.2100, 1.2101, 1.2102, etc. Price swings are so volatile around the news release times, however, that there may be very large price jumps in just a few seconds, meaning that the price could skip from 1.2100 to 1.2115 and never even hit the values in between.
So if you were to place a market order right as this was happening, and it had to take two seconds before the order was filled, due to these rapid price jumps you could enter the market 30 pips away from where you intended to! This is certainly not good, and it can actually have the effect of causing massive gains or losses in the window of just a few seconds. Rapid price jumps most often occur within a 15 minute window of the release of significant economic data.
This is why it is so risky to trade the news, and why the majority of traders like to avoid trading around economic release times. But don't forget that there are a select few talented traders who use opportunities like this to cash up their Aston Martin fund regularly.
The second important thing to understand is the typical manner in which prices fluctuate around the times of significant economic news releases. I have been trading long enough to notice a kind of 'modus operandi' that will occur with forex prices within one hour after the release of important news.
A good exercise that can help you expand your understanding of this is to get into the habit of sitting and watching at your trading station around the time that significant economic metrics are released.
Within 1-2 minutes of the data release, this is the time where there are the largest and most unpredictable price swings. If you are looking to earn pips in a controlled manner you will probably want to stay out of the market during this time and simply watch, or if you trade long-term time frames and shoot for 200+ pip gains then you can simply ignore this piece of news. There, large price swings are due to traders all over the world placing trades right after the release, and you will usually see a huge price swing followed by a correction. After the forex price corrects or retraces itself, this is usually the best time to enter the market.
Look at the data itself, determine whether it is optimistic or pessimistic for the currencies involved, and then place a trade based on that. The general M.O. of currency fluctuations is this initial large price spike, followed by a retracement (this all happens in just a couple minutes), and then over the course of the next hour the price will slowly move in the direction that the economic data would indicate, usually as far as 50 pips or so.
This does not hold true in every case, but more times than not this is how forex price data will react to an important economic news release.
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