News Trading can elicit many negative responses due to the abnormal large number of misconceptions, beliefs and fears that individuals have. News Trading is sort of like leverage a little bit. If you use it right, it can provide an untold number of riches and opportunities for accumulating wealth very quickly. Use it wrong, and you are setting yourself up for immense disaster, losses, and psychological pain.
First let me go over a brief history of news trading as I remember it. Back in 2005 and potentially into 2006, there was a lot of talk about news trading being the new cool system to use. Sort of like it was a new expert advisor that everyone in the market wanted to use that was going to make them a million bucks overnight. What many of those traders back then were doing was called News Spike Trading. News Spike Trading is NOT the “real” way to trade the news.
Now what happens during a news release is depending on the importance of the news release, there will usually be a spike right when the news hits. Let us go over why this spike occurs. Many market participants know that a potential news release can be volatile, so they attempt to position themselves appropriately or go flat before the news hits. This means that they like to close positions, and the closer to the news release time the market gets, the less liquidity there is available, because there are less market participants that want to transact right before the news hits.
You have technical traders that may have a filter in their systems that states not to trade before the news. So they pull their liquidity that they would otherwise have in the market.
You have market makers that don’t want to provide as large liquidity, and so they pull their bids and offers as well.
You have macro traders that don’t want to trade until they can digest the news release impact. So they pull their liquidity as well.
Therefore you have a large number of market participants choosing due to their own self interest, NOT to trade before a news release. They all pull liquidity and this gets reflected in the spread your broker gives you. Depending on your broker and on the liquidity situation in the market, the spread can widen right before and during when the news hits, to anything over 5 pips. The spread can even widen to over 100 pips that I have seen on several occasions. This is where the news spike happens. There is very little liquidity available as the news hits the wires, and the market can get very volatile as the market prices in this new information. The spike occurs and the market attempts to reprice itself for the new fundamental information.
Now what the News Spike Traders were doing were exploiting an inefficiency in certain brokers trading platforms that gave them an execution guarantee on their market orders AND had a lag in their price feed. I believe Oanda offered this guarantee for a little bit back in 2005. They have since corrected that inefficiency and it does not exist anymore. Eventually they figured out they were transferring millions of dollars of money from their own accounts to the people exploiting the News Spike Inefficiency. Now since the broker offered an execution guarantee and their was a latency in their price feed, the trader could figure out via another platform or quote source if the market spiked 100 pips. If it did, they could execute a market order at Oanda’s lagging prices and get in at pre news, or almost pre news prices. They would also attach a take profit order to their trades for lets say 20-60 pips or so. Therefore if the market spiked up 100 pips , the spike trader could have gotten in at 20 pips into the move, because their broker gave them guaranteed fills and had a lag on their price feed, and if they set their take profit for another 60 pips, they can get out of the market at a profit within less than a minute or so when the market spiked the 100 pips, triggered the entry order, and triggered the take profit order as well.
This worked back in 2005 and 2006 for a few reasons:
1. The market was spiking 100+pips for many different news releases as small little changes in job reports, consumer confidence, economic surveys could alter the Federal Reserve’s thinking about when they should stop raising interest rates. Therefore the market perceived the small changes every month in the news releases as having a big perceived impact on the FED’s tightening stance. That is just what they perceived back then and the market was spiking a lot to take that into account.
2. Certain brokers gave execution guarantees to their market orders. They also did not widen spreads during the news as much as they do today. Also certain brokers had a lag in their price feed that did not update fast enough the 100+ pip changes in the market pricing.
So for example there may have been an economic report released. The news spike trader had different broker feeds open. Lets say he had a trading account with Broker A, while using the price feed from Broker B. The spike trader checked to see if the 100 pip spike occurred on the price feed from Broker B. If it did, the trader rushes to place a market order with Broker A. The lag in the price feed with Broker A, allowed the spike trader to get in before the full 100 pips was represented in the quoted price of Broker A.
There were many people making some serious money exploiting that inefficiency until the brokers finally wised up and corrected the problem. How did they correct it? It was fairly simple. All they had to do was correct the lag in their price feed, as well as widen spreads when the news hits. Once they did that, the News Spike Gravy Train came to an end. Anyone exploiting that inefficiency and was still dumb enough to continue trading it started losing money. The wise people took their profits and found another strategy to trade with.
Those prices that the spike traders were trading at never existed in the real interbank market. Those prices only existed in the retail forex market where your broker took the other side of your position. So therefore the news spike traders were taken a lot of money directly out of their brokers pockets. But as I said before, that inefficiency does not exist anymore.
BUT… THERE IS GOOD NEWS
You can still profit greatly from News Trading, but only if you do it right. The news spike traders had no real trading skill. They had no clue what it meant to be a real trader with a real, massive, sustainable edge in the market. It was like they thought they could fly a plane, but once the autopilot was removed, they came crashing down to reality in a painful way.
The good news is that news trading is alive and well. The “real” way to trade the news has existed successfully for over 30 years, and still exists to this day. It actually involves only placing a trade after the news hits after you have had time to see the number, headline, report. Then you need to do research to determine if it will change the market psychology over the next few hours and then make a determination how much of the order flow has already been generated, and how much more will potentially be generated in the future. Most people don’t want to do the research, so they never learn the real way to trade the news. They think they can trade the news with moving averages or stochastic or some other fancy indicators. Those people will never learn…
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