Event-Driven Trading

The Importance of News

· Exchange rate fluctuations are highly correlated with news.

· News that is unexpected tends to have a major impact on the market.

The most important aspect of interpreting news and its impact on the foreign exchange markets is the determination of the market's expectations for that news. In the financial world, this is commonly referred to as the "market discount mechanism". The correlation between currency markets and news is pretty clear. Expected news has little impact on exchange rates while unexpected news, especially when pertaining to potential changes in monetary policy, may have an immense impact. Short-term traders need to closely monitor financial publications like The Financial Times and The Wall Street Journal, as they are excellent gauges of current sentiment towards potential news events. Being aware of events and expectations allows traders to be fully prepared for, and profit from, the discounting of potential market moving events.

Event-Driven Trading

· It is difficult to determine the effect of news on currency movements.

· Traders need to avoid analyst bias and take special care when trading during economic releases

Event-driven trading is a fundamental based methodology that attempts to exploit the volatility associated with economic releases and political announcements. Often times it is quite difficult to determine the effect of news on currency movements, and because of this traders need to avoid biased analysis and adopt a defensive posture during these events. Generally, as fundamental news becomes available, the market as a whole will assimilate the news and move the exchange rates to more appropriate levels as market perceptions adjust accordingly. The event driven trader seeks to profit from this ensuing shift in price. Timing of event driven trades is obviously a key factor to success as positions entered prematurely or belatedly can have significant adverse impacts on P&L. For this reason, profitable event-driven traders usually incorporate some form of technical analysis that helps to validate the merit of the fundamental catalyst.

A Common Error

· News releases can lead to sharp volatility in FX, but this volatility can begin well in advance of the actual announcement.

· Much of this volatility occurs in the days leading up to the announcement.

Economic releases can lead to sharp increases in volatility in the currency markets. This rise in volatility can begin days in advance of an announcement and end days later. The most common mistake made by most novice traders is to enter positions after a particular announcement hits the new wires in an attempt to profit from the perceived good or bad news. What they fail to realize is that if an economic release meets expectations, there will likely be no reaction to the news because it is already 'priced in' to the market. The reaction of the market is based on the market's expectations, not on whether the news was intrinsically good or bad.

Buy the Rumor, Sell the News

· Rather than trade on the announcement itself, some participants prefer to trade on the rumors that circulate before its release.

Bank dealers and institutional traders often adhere to the old Wall Street adage of "buy the rumor, sell the news". Rumors of a positive report will typically begin to circulate among trading desks and hedge funds days before an expected release date. The institutions will then use this information to position themselves on the long side. When the news comes out as expected, they then sell their positions to a frantic public, profiting from the run-up to the announcement as opposed to guessing the reaction to it.