Adam Buttons

Secrets to
Trading the News

8 Secrets to Trading the News

Contents
3

Introduction

Watch the Soap Opera

Whats Expected Is What Matters

Whats Expected Isnt Always Whats Expected

Dont Fight the Narrative

10

Trade the Skew

11

Fade Moves on Disasters

12

Uncertainty Breeds Contempt

13

Beware the Growth Trap

8 Secrets to Trading the News

Introduction
Trading headlines is a great way to earn a living from markets. Computers
can trade technical patterns, and algorithms can arbitrage different markets,
but they will never be able to fully interpret news.
Reading a headline, understanding what it means and making a trade is
one of the most rewarding experiences in markets. Its the feeling of being
completely synchronized with the market and understanding its rhythm.
Every situation is different and nothing unfolds exactly as planned, but
there are some ways to get an edge when youre trading news. These tips are
designed to help you make money.

8 Secrets to Trading the News

Watch the
Soap Opera
All news isnt created equal, not by a long shot.
Whoever wrote that markets are efficient didnt live a day as a trader. Markets
move on the whims of people and, even collectively, people can be irrational.
Markets adopt themes, and traders quickly fall into the habit of trading them.
As this happens, correlations change and the same news brings a different
reaction. There is no dogmatic answer to the question What matters?
because the market evolves.
The market is like a soap opera. Every day is full of twists, drama and
cliffhangers. The most important thing is to stay immersed in the story.
When you miss an episode, the plot is harder to follow and understand. Over
time, characters and storylines appear and fade out.

I wouldnt mind
so much if I
knew what was
happening on
the soaps.

For someone who trades news, taking a week of vacation can be a frightening
thought suddenly the story makes less sense and the flow of the market is
harder to digest.
Thats not to say its a full-time job to follow the news. Even the most cursory
market reports offer a sense of what matters to markets.
The main takeaway is to understand that whatever theme is in the spotlight
will impact markets more than it really should. It means that at one time
Greek election polls meant more than German GDP. At one time, US
housing starts meant more than non-farm payrolls.
In general, the market divides its focus between growth and inflation. When
you stay on top of the story, you can stay on top of the trade.

8 Secrets to Trading the News

Whats Expected
Is What Matters
On an airplane recently, I was reading a Wall Street Journal story on the latest
non-farm payrolls report. The headline said it was the worst jobs data in eight
months, and the story was filled with sensationalism and data. Economists
talked about what it meant for the economy and mused on the reasons for
high US unemployment.
I finished the article disgusted because it never mentioned what was expected.
Unemployment could be the worst in twelve months; heck, it could be the
worst in five years, but what matters to the market is whats expected.
Market prices arent built only on what we know about the past and present;
the main element is the future. If the UK unemployment rate rises to 8.1%
from 7.9%, thats bad news if youre a worker. But if expectations were for a
rise to 8.5%, then its great news if youre long on the pound.
Markets constantly weigh new information to try to form a picture of the
future. The market has a clear image of how the economy performed in the
past, a good sense of how its performing in the present and a murky idea
of how it will do in the near future. Markets change as the murky idea
gets clearer.
How are expectations formed?
Economists wield tremendous power in markets, and I dont mean the
economists at your local college. The economists who matter are part of
teams of people who sit adjacent to the worlds largest trading floors and
forecast nearly every economic data point.
The good ones are responsive to markets and adjust forecasts in real time.
Some build complex models to make accurate forecasts. In the world, there are
perhaps 200 groups like this. They are called qualified economists, and their
forecasts are collected by major news services like Bloomberg and Reuters.

8 Secrets to Trading the News

2
The aim is to collect as many forecasts as possible on every piece of economic
data. The idea is that a sampling of economists estimates will accurately reflect
market expectations. If there are 45 estimates for an economic data point, they
are sorted and the median forecast is listed as the consensus estimate.
Understanding whats expected gets a bit more complicated when data
isnt involved. Elections can have many outcomes, government budgets are
complicated and trade deals are difficult to quantify.

You could put it all into bricks

But I recommend diversifying your
investment to include sticks and
straw as a hedge.

At the end of the day, everything affects markets, but at the bottom line there
are growth and inflation. Of the two, growth is the more important because
it usually foreshadows inflation. Every piece of news fits in the growth puzzle
or the inflation puzzle so, most importantly, understand what kind of growth
and inflation is expected.

8 Secrets to Trading the News

Whats Expected
Isnt Always
Whats Expected
Traders with a cursory understanding of expectations are dogmatic. They look
at the Bloomberg survey of economists expectations and assume it aligns with
market expectations. That isnt always the case.
First, understand how the consensus estimate is reached. News organizations
poll the head economists from big banks and research firms on what
they expect. They usually come to these numbers using economic models
or regression analysis. In other cases, the numbers are little more than
guesstimates. An important US indicator might have 5060 estimates, while
a second-tier indicator in Australia might have fewer than 10 forecasts. No
matter how many estimates, the median forecast is used as the consensus.
The first way to gain an edge is to understand that there is a time lag in
expectations. Many economists estimates are collected a week or two before
the data is released. In the time between, a number of data points could change
the outlook, and its rare for economists to update forecasts.
For instance, in the week before non-farm payrolls, there are many other
employment indicators, including the ADP estimate, the ISM employment
components and initial jobless claims. As these are released, the market
changes its expectations. The consensus might remain at 180K for non-farm
employment change, but if those indicators are soft, traders will already have
priced in a reading near 150K.
If the result is 165K, the knee-jerk reaction might be for USD/JPY to go lower,
but traders who truly understand what the market expected are buying, and the
market is likely to reverse. That difference between economists expectations
and market expectations is a way to gain an edge.
Another instance when market expectations differ from economists
expectations are events that have binary outcomes. The most common is an

8 Secrets to Trading the News

3
interest-rate decision that has only two realistic outcomes: cutting interest rates
or leaving them unchanged.
With central bank decisions, polling economists to understand whats
expected is filled with pitfalls. If 11 of 20 expect a rate cut, then a rate cut
is the consensus, but its not immediately clear how close it is. If 17 of 20
expect a cut, it appears to be an overwhelming consensus, but a dozen of those
economists could believe its a very close call.
Aside from these obvious problems, economists have a tremendous amount of
pride in correctly predicting the path of interest rates. If a team of economists
have been predicting a rate cut for the past eight months, they loath sending
out a note to clients in the days leading up to the decision admitting theyve
been wrong all along.
Instead, look to derivatives markets. Overnight index swaps are often used as
a proxy for interest-rate expectations and they give market-based information,
which is far more accurate than economists predictions. They can also be
boiled down to percentage probabilities. An economist will predict rate cut or
no rate cut, but the OIS market can show a 40% chance of a cut.
The difference can be huge, and if there is any discrepancy, always go with the
OIS market.

8 Secrets to Trading the News

Dont Fight the

Narrative
In a sense, markets are all numbers data, prices, profits and pips. Its easy
to try to tie a probability to every event and lose track of the bigger picture.
Trends happen because of stories: the Australian dollar has soared because
of a decade-long mining boom. The Japanese economy has floundered for
a decade because of near-zero inflation. The US recovery is built on rising
home prices and consumer spending with employment gains on the way.
If you understand the narrative, its much easier to see where news fits
in. Sudden strength in manufacturing would add a third pillar to the US
recovery and make those employment gains more likely. Several more soft
manufacturing reports might mean nothing because they dont change the
underlying story.
Sometimes the story the idea can be more powerful than the
numbers. This is always the case with bubbles: buying real estate is always a
good investment. Gold is the only true store of wealth. China will power
past all challenges. These are all examples, but the market flirts with smaller
ideas constantly.
The idea of US energy independence is a growing, powerful force in markets
that threatens to underpin a long-term dollar rally.
When an idea grips a market, oftentimes the data doesnt matter. Tech boom
Internet companies never made money or showed a reasonable path to
profitability, but they traded at incredible valuations.
As Galbraith said, markets can remain illogical longer than you can
remain solvent.
Some trends cant be fought with logic; embrace them. If youre waiting to
fight an illogical trend, you will have to be incredibly patient and accept that
timing the top is impossible.

8 Secrets to Trading the News

Trade the
Skew
What if I told you about a level in a market that couldnt be breached? Such as
a ceiling or floor restraining price action.
For example, the Swiss National Banks EUR/CHF floor. Officials drew a line
at 1.2000 and promised to sell the franc in unlimited quantities to protect it.
There were questions about the credibility of the promise, but it has been kept.
When you bought the pair at 1.2020, the downside was limited to 20 pips but
the upside was unlimited.
Sometimes news events are like that. Clear lines like 1.2000 rarely apply, but
oftentimes markets head into news events in a position where its easier to move
in one direction than the other; thats called a skew.
I can illustrate with an economic data report. If the ISM manufacturing index
is expected at 51, the data could be either stronger than expected or weaker
than expected. Assuming an equal probability of either stronger/weaker, its a
coin flip, but market positioning isnt always like that. USD/JPY might have
climbed 5 days in a row heading into the report on expectations that the
Federal Reserve would hike interest rates; there could also be a major level of
technical resistance nearby. If the report comes out stronger, there isnt much
upside left in USD/JPY, maybe 30 pips. On the other hand, if the report is
soft, it could change the dialogue and cause a powerful round of profit taking,
maybe 80 pips. Thats skew, and its something traders are always looking for.
Finding a skew in the market isnt always straightforward, but the way to search
for it is by working through different scenarios. Anticipate many different
outcomes and imagine how the market will react.
Not only is this a great way to find a skew, its also an ideal way to prepare for a
trade and learn about the theme in the market.

8 Secrets to Trading the News

10

Fade Moves
on Disasters
Fear is the easiest emotion to trade against.
When an entirely unexpected event like a natural disaster or geopolitical
event takes place, the first reaction on trading floors is always the same
close positions.
Markets react to these events extraordinarily quickly the combination
of uncertainly, confusion and fear means a rush to the exits. Trading floor
televisions captivate risk managers and traders lose focus. Its a very delicate
mental state, and when the market begins to move, everyone wants out.
It doesnt take an especially cool head to trade at those times because the
outcome is almost always the same. Fading the panic move is a surefire way
to profit. Unless the news means a third world war, the market will rebound.
And if it does mean a third world war, were all done for anyway.

Look at the bright side. Its better

to have loved money and lost than
never to have invested at all.

Natural disasters are terrifying, but human nature is incredibly resilient.

We rebuild stronger, and the economic impact is always less than feared.

8 Secrets to Trading the News

11

Uncertainty
Breeds Contempt
Many market axioms are beaten to death, but I think that one is not repeated
often enough.
The flip side of knowing what is moving the market is to know what isnt
moving the market. There is always an analyst willing to go on TV and attach a
7.3% decline in the Japanese Nikkei to a softish data point from China. If you
know the theme, the story and whats important, you know that the decline
isnt true.
When you know the news, you know that sometimes market moves are
inexplicable; this happens far more often than analysts like to admit.
At a certain level, this is okay. Flows move the market, and 4050 pip moves
in currencies are part of the background noise. In those times, it pays to be
comfortable with the uncertainty because it can be used to establish positions.
The game changes when headlines cross and traders expect it to mean one type
of reaction, but the opposite happens or it happens on a scale way beyond
whats normal. People scramble for explanations, and traders with a fringe
knowledge of the news accept market fluctuations so they act as though
nothing has changed.
At this point, good news-traders start to realize the pieces no longer fit, and
they begin to close out positions. Great traders begin to fade all the most
popular trades because they realize that contempt is coming because when the
pieces dont fit, traders head to the exits.
When the stories begin to break down and volatility begins to rise, position
for contempt.

8 Secrets to Trading the News

12

Beware the
Growth Trap
Its not about the state of growth; its about the pace of growth.
The market doesnt like good growth; it likes accelerating growth. China may
be growing at 8%, but it was growing at 10% before, and the slowdown in the
pace of growth is what matters. This is called the second derivative, and its the
tectonic plate that markets shift on.
Traders found it extremely difficult to invest in Europe since the crisis because
growth was nil. But markets can rally on zero growth if its stabilizing after a
recession. In fact, thats often when you see the strongest markets. A currency
doesnt bottom when growth bottoms; it bottoms when the pace of contraction
begins to slow.
This rule is clearest for growth but it applies for all news. Markets move at the
margins, not in the absolutes.

8 Secrets to Trading the News

13