20-Year Veteran Bank FX Trader Talks About USD News Trading
News as Leading Indicator of U.S. Dollar Price Movement
“New news” is what drives the currency market; it can be found in: 1) Speeches, interviews, and testimonies by key government officials. 2) Press releases, monthly and quarterly bulletins, minutes of meetings, and reports 3) Scheduled monthly and quarterly economic releases. Many of you are probably familiar with news trading scheduled economic releases. Back in the day of guaranteed stop losses, straddling key economic indicator releases was very profitable and popular. To the best of my knowledge I was the first FOREX advisor to recommend these news straddles; that was about two years ago. Since then I have developed a new set of strategies to profit from the news. These strategies are better than the old news trades because there is no gimmick (such as exploiting guaranteed stops).
Identifying “new news” is easy provided you know what you’re looking for. Let me give you an example. Last fall within a 6-week period half a dozen Federal Reserve Bank Presidents included a discussion of the U.S. Current Account and its negative implications for the U.S. dollar in their regularly scheduled speeches and interviews; soon afterwards the USD broke out of its trading range to the downside. There is no question in my mind that this was a pre-planned strategy to lower the value of the dollar; this is called talking the dollar down and it’s much more effective and much more politically correct than intervention. The mastermind of subtlety himself, Alan Greenspan, really nailed the coffin shut on the dollar when he spoke at the European Banking Congress on November 19, 2004.
If you recall the dollar had dived and the Europeans were calling for joint intervention and hoped Mr. Greenspan would address it. He did. In the footnotes to his speech Alan pointed out that intervention doesn’t work and most times makes the situation worse. In the footnotes Greenspan also answered the question of where the dollar was going; he referenced a 2001 Fed study that stated given the present size of the current account deficit in relation to GDP “a 10% to 20% real depreciation” of the currency should occur. Without speaking a word about joint intervention or where the USD was going, he expressed his opinion clearly on both points! The result being the dollar got buried further right through to year-end; the depreciation the Fed sought was realized without “firing a shot”.
Was the January Dollar Sell off Predictable?
If you missed the January USD rally you weren’t paying attention. Those same Federal Reserve Bank Presidents that bad mouthed the dollar in the fall came back in full force in January, all singing the same USD bullish tune this time: 1) Current Account will improve due to past USD depreciation. 2) Federal Budget Deficit will be significantly lower this year and also in subsequent years. 3) Economy is strong and inflation subdued. 4) Interest rates could go a lot higher sooner than the market perceives under certain circumstances. The reasons for this sudden change in spin on USD prospects may never be fully known. Perhaps Some covert deals were done quietly that we will never know about. What’s for certain is the dollars January rally was in no small part caused by positive Fed talk.
“New News” has Maximum Impact when Technical Conditions Suit
It appears the catalyst or first mover for the rise in the dollar was Greenspan and company but without a strong technical condition present, the move may have only been a fraction of what actually transpired or may not have happened at all. The USD being severely oversold at the end of 2004 had a lot to do with why the dollar went up at the beginning of 2005. In formulating news trading strategies it’s imperative to have a clear understanding of the technical condition of the market. I don’t mean whether the price is going up or down; what’s key is whether the market is long or short. The best moves are caused by desperation; longs or shorts panicking to get out of their right positions or wrong positions. There is a pattern to trading behaviour in this regard.
As a general rule, market opinion and positions become lopsided when the market trends; the longer the trend, the more lopsided the market opinion and the positions become. This re-enforcing characteristic of trend trading is what causes the price to move further and further from “reality”. When “new news” provides a dose of reality, the potential for a strong countermove exists. If the price action starts to move in favour of the countermove the initial stage is “dip trading” or bargain hunting. If price continue to move against the prevailing trend a string of concurrent and consecutive stop losses gets triggered. “New news” means something has changed and is oftentimes the beginning of trend reversals. Awareness of “new news” allows the trader to get in early.
What’s key to keep in mind is that the “new news” may not be apparent to the market right away. So entering prematurely is an obvious risk. That’s why the charts and technicals are an integral part of the strategy, especially the market sentiment / technical condition of the market. As I said earlier the market sentiment will not change immediately, simply because the market does not pay close attention to the news; the markets focus is fixated on price. Only if and when the price action begins to reflect the news will the market’s awareness of the news occur. So the “new news” strategy is to be aware of the change that took place and looking for an entry point to profit from the information. Charts are very helpful in pinpointing a “safe” place to put the trade on.
“New news” can be very effective in breaking a stalemate – trading range. We saw that in the late summer when the USD was directionless, bouncing back and forth between 120 and 124 versus the EURUSD for example. The Greenspan clique put the negative spin on the USD and got the bear market rolling. Chart wise catching the breakout in EURUSD was not difficult in hindsight but then again there were many false breakouts during the summer. The point is when there is a good fundamental reason why a breakout is occurring, the chances of the breakout sustaining increases dramatically. I did a simple study to prove this point. I downloaded the 15 minute time frame price action in NZDUSD for all of 2004. I sorted out the 30 biggest up moves and listed them chronologically according to time of day.
The results were stunning and proved my point precisely. All the big price moves that occurred at 8:30am Eastern Standard Time sustained a large percentage of their gains and closed the 15-minute time frame near their highs. There was a sizable group at the 2am Eastern Standard Time; NONE of them sustained their gains; some actually closed lower at the end of the 15 minutes. There were several at 5pm EST; same story – they closed either unchanged, slightly up or down for the 15-minutes. I concluded from this study that charts and technicals alone would catch the initial moves but the ones that were true moves – sustained – were practically all news related. Therefore the formula is playing the chart breakouts when the news is causing the breakout.
Another important distinction is the difference between traders getting into positions and traders getting out of positions. The big moves are much more likely to occur when traders are getting out of positions. When a trader misses an entry trade it’s no big deal just a forgone opportunity cost. But when a trade is bailing out of a position, especially at a loss, a missed trade means a bigger loss and MORE of a sense of urgency. It is when the market is chasing and not sensitive to price that the big, exaggerated moves occur. This happens most often when the charts are “lying”, in other words when the price action looks ok and then suddenly and unexpectedly takes a turn for the worse. When market sentiment is one-way this often happens. What was a buy on the dip becomes a panic sell.
Many Ways to Trade Reoccurring Monthly Economic Indicators
Figure 1 is an example of a set up for a big move down in EURUSD related to panic stop loss selling. EURUSD sustained a 200-point up move after the release of horrendous trade numbers on January 12th. The price action indicated long positions were established between 1.3200 and 1.3230. It was reasonable to assume these were hefty sized positions taken for the longer-term pull. The EURUSD had fallen sharply in early January and these levels looked like a bargain at the time; especially after the market focus –trade numbers – were horrible. The following day the EURUSD drifted lower to the dismay of the longs but clearly held above the “danger zone”. The next day these longs were clearly on the ropes. EURUSD tested 1.3200, held and retraced up to the 1.3230 area.
Now the fun part comes. If EURUSD clearly breaks below 1.3200, these long EURUSD positions are probably wrong. The owners of these positions know this so they will put in their stops. Once the first stop is triggered it will cause a chain reaction whereby the triggering of one stop triggers a lower stop and a vicious down move will likely occur. This appears to be exactly what happened on January 14th. What’s key to remember is this down move is the direct result of the trade number that came out two days earlier. Being aware that such a condition was present in the market is key to catching this freefall in the EURUSD.
Figure 2 is another example of using the “new news” in conjunction with the charts and technical condition to pinpoint a big move waiting to happen. The set up is the EURUSD crashed during the first week of January and a lot of hedge funds and CTAs got caught in the downdraft. Friday’s payroll proved to be the straw that broke the camel’s back. The number was worse than expected, the EURUSD was “oversold”, and so a big EURUSD up move was the call. A down move was not even on the radar so if EURUSD went down the market would be caught with their pants down and pockets emptying quickly – a definite panic button situation in the making. Determining when the panic button would be pushed was easy – below the non-farm payroll pre-release EURUSD price!
The pre-release price was 1.3175 (EURUSD rate at 8:2959). The non-farm payroll number was worse than expected so the knee jerk reaction was to jack up the EURUSD price to 1.3240. The 1.3240 becomes a pivotal level, as does the 1.3175 pre-release price. Failure to break above the 1.3240 level would be a sign of potential EURUSD weakness. In other words, it’s non-farm payroll Friday, which typically means it’s a wide range EURUSD day (oftentimes much of the range occurs in one direction but wide range non the less). A break below the pre-release would be a clear sell signal –after all the non-farm payroll was less than expected and the EURUSD was down 500 points on the week (had to be oversold right?). The market was long and wrong and when EURUSD broke 1.3175 it was “gone”.
Figure 3 is the following month’s non-farm payroll. What happened on Feb 4 was very similar to what happened on Jan 12; only quicker. It took the market just a matter of minutes to figure out that the somewhat worse than expected non-farm payroll number was not going to create a sustained rally in the war torn EURUSD. The 15 minute chart does not do justice to how easy it was to catch this trade. After the EURUSD rallied to its highs around 1.3040, it was so offered on the way down that anyone with more than a weeks FOREX trading experience would have sold it. Provided of course that their focus was on the EURUSD not going up as the bad non-farm payroll indicated it should have; if they were oblivious to the obvious and buried in technical indicators they could have missed this trade.
Why Time Based Technical Indicators are Fundamentally Flawed
The knock I have on new FOREX traders these days is they are too scientific. They ignore the leading indicators (fundamentals) and the obvious (simple up and down price movement). Basically, if it doesn’t require a scientific calculator, they don’t focus on it. Here is what Einstein would say “We must learn to differentiate clearly the fundamentally important, that which is really basic, from that which is dispensable, and to turn aside from everything else, from the multitude of things which clutter up the mind and divert it from the essential”. In currency trading “new news” is fundamentally important and how the market responds to it (the price action that follows) is basic. Everything else, like Stochastic, Relative Strength, MACD, Bollinger bands etc., is clutter.
These “exotic” technical indicators all have an additional common denominator – TIME. I have no use for time in any of my FOREX trading analysis. The obvious flaws in time / price analysis are: 1) The FOREX market is only volatile between the European opening and the European close. There are exceptions such as extended price action on major U.S. economic release days, where the fun lasts into the New York afternoon, but most days the market is dead by New York lunchtime. The lack of price movement between say 12pm and 12am generates all kinds of technical trading signals. Common sense – the price is not moving because nobody is trading – what can these signals be possibly signalling? Suggestion – make sure your technical signals are reflecting price action and not the lack of it.
A second serious flaw in time / price analysis is the impact of derivatives on the FOREX market that has only come about in the last 15 years. Its key to realize the momentum based technical indicators were developed during the 1970s and 1980 BEFORE derivatives impacted the FOREX market. So far example in 1980 when Boeing Aircraft needed to sell 500 million GBPUSD they called a Bank and said sell 500 Pounds. The first couple of hundred the bank sold would be for the traders account and a few key players in the trading room. Next would come the client’s interest. The trader would sell 300 and if the price seemed offered he would sell the full 500. At that point the client is called and given a fill; the average sale price on the 500 sold on behalf of the client. Now comes the good part.
As soon as the salesman is done reporting the fill to the client the trader covers the “banks” 200 short position, sold at “designer” prices before the clients sale, at a huge profit. The trader may buy an extra 200 to boot, depending upon how “it felt” covering the initial 200. As you can imagine given this scenario, which was a daily ritual, independent traders, not privy to the banks doings, but using technical indicators did very well. The old MACD would get them in on the initial selling and MACD or any other indicator would alert them when the tide had shifted. Fast forward to 2005. Boeing has a FOREX expert handling its foreign exchange business. Boeing will be receiving 500 GBPUSD in six weeks time; the related import transaction has a reference rate of 1.8800.
The Boeing person calls a Bank salesman and asks what the market is doing in Pounds. The Bank salesman and the Boeing FX expert have a conversation and the salesman gets the feeling Boeing has Pounds to sell but is reluctant to do so because their view is bullish on Pounds and perhaps they can wait for a higher rate. This would suit the salesman perfectly; in 2005 because of transparency and competition the bank can’t make any real money on a spot transaction anyway. So the salesman goes into his act. He suggests Boeing writes a double knockout option.
It works like this. Boeing sells the right to the bank to buy 500 GBPUSD at 1.8900 in six weeks time, provided GBPUSD trades at 1.9000 (knock in) and does not trade at 1.9500 (knockout) or 1.8600 (knockout).
The bank will pay $3,750,000.00 for the option; that’s the equivalent of 75 GBPUSD points. Lets look at possible outcomes for Boeing. 1) Best case. The GBPUSD goes to 1.9501; the option gets “knocked out”, Boeing sells the Pounds at 1.9500; earns $3,750,000 for the option plus $35,000,000 on the sale of the Pounds (700 points on 500 million Pounds). 2) Worst case. Pound declines to 1.8600; option gets “knocked out”; Boeing sells the Pounds at 1.8600; add back the 75 points earned on the option – Boeing sold the Pounds at 1.8675; just $6,250,000 less than 1.8800 sale would have yielded. What’s key is expert gets to trade his opinion for a low cost and huge upside potential. Now lets think about how this derivative contract will impact the spot GBPUSD market.
Lets say five and a half weeks down the road the pound reaches 1.9475. At this point the bank has a profit of $25,000,00 on the option (see figure 4). However if GBPUSD trades at 1.9501, the bank has a loss of $3,750,000. Conversely, Boeing at 1.9475 has a profit of $8,750,000 (see figure 4). At 1.9501 however Boeing has a profit of $38,750,000. It should be obvious that the bank has a hell of a lot of incentive to stop the Pound from reaching 1.9501 and it should be equally obvious that Boeing has a lot of incentive to “make” the Pound trade at 1.9501. This is a classic option barrier war in the making. There will be a winner and a loser of the war. One thing for certain, the bank and Boeing will be fighting out a private battle that only they know about.
Conclusion
Most of the time based technical indicators came about from the price action data collected by the IMM in Chicago in the late 1970s and 1980s. Before derivative FOREX products these indicators proved very useful in FOREX trading. Today however, I believe they give as many wrong signals as right signals because the forces in the market today are completely different than what they were 20 years ago, yet these indicators remain the same. I believe a trader can be do much better if they forget about time based technical indicators entirely and focus on the “new news” and how the market reacts to it. This requires a basic understanding of FOREX fundamentals and simple chart reading techniques.
