Two Cases When Trading News Events Goes Wrong

6

Reaction to news events in foreign exchange trading is driven by expectations. A headline result that is above expectations leads to strength in the respective currency, while a headline result that is weaker than estimations results in a weakening of the respective currency.

Unfortunately, life isn’t that easy and there two general exceptions that traders should be aware of.

The Risk Factor

First, the US indicators tended to produce the opposite result for the dollar. The reason was the risk on / risk off mentality, whereas a weaker than expected US indicator leads to a strong US dollar (and a stronger Japanese yen).

The explanation is that a weaker US will lead the world down, and therefore, it is better to fly to safety – the safety of the US dollar.  And when indicators exceed expectations, the world is set to improve as a whole, and no safety is needed and the dollar is sold. Risk is sought after.

This kind of behavior was seen for long periods of time in the period after the financial crisis. However, the never ending expectations for QE3 resulted in a return to “normal” behavior. Weak data raised QE3 expectations. Creating more dollars to buy bonds weakens the US dollar. And positive figures lowered the chances, strengthening the dollar.

If QE3 turns into reality (even though the Fed could take a different path), the question of QE3 will not exist anymore. So before QE4 will loom, we could see a swift return to the “abnormal” behavior.

Sell the Fact

The second exception is usually seen on a big event that has fewer possible results: an event such as a rate decision, where there is usually one main scenario. Of course, high expectations that don’t materialize lead to a disappointment. This is a natural fact of life.

There is another scenario, where high expectations do materialize. However, these expectations were priced in or even “over priced in” that any result leads to a sell off. This is often dubbed “buy the rumor, sell the fact”, and is relevant also when the event isn’t a rumor but a well-known scheduled and thoroughly debated event.

For example, a future rate cut in Australia may result in a rally for the Australian dollar if this event would be priced in. This is despite the usual behavior of a rate cut hurting the respective currency and despite reality meeting expectations.

Further reading: 5 Most Predictable Currency Pairs – Q3 2012

Get the 5 most predictable currency pairs

About Author

Yohay Elam – Founder, Writer and Editor I have been into forex trading for over 5 years, and I share the experience that I have and the knowledge that I’ve accumulated. After taking a short course about forex. Like many forex traders, I’ve earned the significant share of my knowledge the hard way. Macroeconomics, the impact of news on the ever-moving currency markets and trading psychology have always fascinated me. Before founding Forex Crunch, I’ve worked as a programmer in various hi-tech companies. I have a B. Sc. in Computer Science from Ben Gurion University. Given this background, forex software has a relatively bigger share in the posts.

6 Comments

  1. First paragraph, possible typo: “A headline result that is below expectations leads to strength in the respective currency…”

    Did you mean “above”?

  2. I’ve always known the saying as “buy the rumor, sell the news” for some reason, but sell the fact is better. I can definitely say that in my years of trading that following this general rule has done very, very well for me. It just repeats, and repeats, and…

  3. Pingback: EUR/USD Triple Top Ahead of Draghi | Forex Crunch

  4. Pingback: USD/JPY at 7 Month Low Ahead of the Fed – Time to go Lond? | Forex Crunch