When trading news, there are three questions we need to ask ourselves before each trade: Is the news important? Is the surprise big enough? And is the surprise consistent with market sentiment?
1. Is news important?
The first task at hand is to determine what is important and what is not. The top three components of potential market-moving economic data for any country are employment reports, retail sales, and data on manufacturing and service sector activity, also known as ISM or PMI reports. In addition, Gross Domestic Product (GDP) is published and inflation reports (consumer and producer prices) are also transferable. Reports like the base book that are not for sale because there is no fixed number to compare, the data is published weekly and any Japanese or Swiss economic report is almost always overwhelmed by the general sentiment of the market.
If you have a hard time figuring out whether data is transferable, most forex sites will list the impact of each piece of data on the currency. High-impact events are the ones we want to trade
2. Is the surprise big enough?
The second question is the most complicated of the three because it is subject to interpretation, but the good thing is that the market will usually do the explanation for you. As a rule, if the number is more or less than 5 percent of the forecast, it is considered a big surprise, but sometimes 2 percent is enough to make a big response to the surprise coin.
So what should you do now? Just wait and see how the market responds to the release. If the currency pair is barely low, then perhaps, the surprise is not so significant. If the currency pair immediately shoots high or falls like a stone, there is a good chance that the market was surprised. The key is to wait five minutes before entering the trade to make sure the currency responds as expected. In other words, a positive surprise should reduce the currency pair to a higher and negative surprise.
3. Is the surprise consistent with market sentiment?
The third question is important because sometimes economic data is something that we usually expect a big response, but that is why the rally quickly becomes cloudy or the traders do not notice it.
This usually happens when something else overwhelms the data and drives common sense in the Forex market. This could be anything from US data risks or concerns about Europe’s problems. This is a strong trade-off if economic data surprises or “fundamentals” are consistent with existing sentiment in the market. In other words, if the market wants to buy dollars and retail sales are strong, this usually gives forex traders a better reason to send higher greenbacks. However, if the market is concerned about the outlook for the US economy because the Federal Reserve warns that there will be more problems to come, then good data cannot do much for the dollar because it will be viewed with suspicion.
Existing market sentiment can be difficult to measure, but moving averages can help because they measure current market trends by averaging a certain number of past prices. If the data is good and the currency pair trades above the 50-period moving average on the 5-minute chart (or breaks the currency above the data moving average), then sentiment and fundamentals are likely to improve. However, if the data is good and the currency pair trades well below the 50-period moving average, it suggests that existing sentiment does not support the economic surprise. In this case, we will not trade because we want to keep the main variables aligned for us as much as possible.
In short, we only want to trade important economic data, surprisingly large enough to cause a reaction in the currency, and only if the economic data is consistent with the general sentiment of the market. With these guidelines in hand, I show you how fast and furious news trading works.