Knowledge is Power. Take Your Trading Head Out of the Sand

It is said that knowledge is power and in the world of trading it means you need to be aware of what consensus forecasts and range of estimates are for upcoming economic releases. It is a surprise in the results that move the market.

As I noted in How to Trade By Taking Advantage of News Rather Than Letting News Take Advantage of You

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.

Let’s take a look now at why you need to take your head out of the sand and be in sync with what economic forecasts are showing.

Surprise. vs. Consensus

It is important to be in touch with consensus forecasts (see Global-View economic calendar) and the range of estimates for upcoming economic releases. When a data news release deviates from the consensus, it is considered a surprise that is followed by a market reaction. Sometimes it is just a sharp, short/lived knee-jerk reaction. Other times it can lead to traders reassessing the outlook and adjusting their positions based on the new data.

Emotional Reaction

A data surprise can lead to an emotional reaction by traders as they act first and then reassess later. This can see an outsized reaction to data as traders react more to the headline than the details. This is why such reactions often prove to be short-lived although other times it can lead to a more sustained move.

Algos:

With the increasing growth of automated trading systems, an outsized reaction to a data surprise could be exacerbated if it leads to strong buying or selling by mindless algos.  This should not be underestimated, especially if the price moves breach any key technical levels that forces the algos to trade or adjust positions.

There is another part of the algo argument. The advancement of electronic trading is that algos provide liquidity for the market. When there is a news release, especially a surprise, the or pull in volatility will likely see liquidity algos pull back on bids or offers and this can exacerbate the reaction on an temporary imbalance in the market,

Risk On vs, Risk Off

When there is a surprise in a data release that veers significantly from the consensus, it can lead to a reassessment of risk by both traders and investors. The reaction may depend on what the current theme is in markets.

For example, stronger than expected economic data could see a risk on (i.e. rally) n equities based on an improved outlook for the economy. However, in other times the same data could lead to a sell-off if it raised concerns about inflation and higher interest rates to combat it.

This is why you need to be in sync with the current market theme so you can evaluate how to trade the reaction after a surprise miss in the data.

Spill over Effect

In the current trading world, markets are connected with movements in one influencing price moves in others. For example, forex, stocks, bonds, and commodities are all influenced by one another and each seems to take turns leading. You can see this after a surprise news release, with each fueling off the other.

Fundamentals

The extent to which a miss in data on either side can impact expectations of monetary policy can result in a more sustained reaction. The key word here is expectations. A surprise in the data can influence sentiment and what is priced in regarding central bank monetary policy

In my article, Trader Alert: Beware of a Market Surprise, Ask Those Short EURUSD, I conclude by saying

So, don’t trade with your head in the stand. Don’t just look at your upside but at your downside risk as well. If you don’t like the risk, step aside. If you are okay with the risk, look ahead to what would produce a surprise. This is just a trader like you giving some advice, not just from common sense but from experience.

So, remember, knowledge is power, which includes trading.

Jay Meisler, co-founder, global-view.com

jay@global-view.com