The Difference Between Reaction and Response is Worth Hundreds of Pips

Boris Schlossberg

It’s been an intoxicating week at BK. We’ve been winning on every trade structure – swing, news trading, day trading and even algo. A big part of the reason is simply the much more accommodative market environment. Nothing like pick up in volatility to make your continuation trades hit all their profit targets.

But it’s something more. The ability to win on both the news level and the swing level made me realize that I am starting to master a very distinct set of skills, that are really useful in understanding how markets really operate.

One common refrain that I often hear from retail traders is, “I never pay attention to the news. It can’t help your trades anyway.” Although I refrain from saying this to their face, my immediate thought is that the only thing stupider than that statement are traders who tell me, “I never pay attention to technicals, they are just squiggles on a screen.”

Both attitudes are woefully myopic because trading is always and forever a mixture of fundamental catalysts, market positioning (trend) and price levels. It is a multi-factor game and just looking at “squiggles on a screen” or chasing the latest headline is a sure path to ruin in trading because you are flying partially blind.

Still, because retail traders are predominantly technically oriented and pay only cursory attention to fundamentals it’s really important to understand the difference between news reaction and news response.

One of the reasons that so many retail traders are frustrated by news trading is that it seems to follow Murphy’s rule of law. Good news gets sold and bad news gets bought. Nowhere is this more evident than in commodity dollars where a few primary bank dealers control the order flow and enjoy nothing more than wrong footing traders who chase headlines.

Let’s understand what happens when FX news comes out. The moment the headlines hit the wires algos from HFT firms like Citadel and Virtu will sweep all the offers or hit any bids in a matter of microseconds. So often the move between pre-news and post news highs or lows is accomplished within a 1-minute candle leaving absolutely nothing for the point and click retail chasers who are fighting latency and wide spreads. Furthermore, the dealers who are on the opposite side of this flow have now inventoried a lot of one-way trades and need to carefully unload their position at a profit.

Contrary to the paranoia you’ve heard in retail chat rooms, dealers are not “always manipulating the market”. They are just doing their job as liquidity providers while trying to keep a positive P/L. So naturally, prices will often rise after an initial sharp drop or fall after a spike higher. That’s how the game is played, so don’t hate the player.

This is simply news reaction and in BK Live Trading I often take advantage of that dynamic by doing the exact opposite of what makes common sense and capture the “retrace profit” along with the dealers.

But news reaction is frankly chump change. The real money in FX trades is made on news response when a piece of data has far-reaching implications that go beyond the next few hours or even the next few days. A prime example of this dynamic at play was the RBNZ presser in March. The New Zealand central bank announced a clear shift to an accommodative stance, essentially warning the market that a rate cut was coming. The price instantly dropped but then actually consolidated and rallied for a few days after.

N00b traders would be forgiven for thinking that this was the end of the story, but for traders who actually understood news response this was just the beginning. That’s because the markets players who truly move prices – the corporates, the hedge funds, the asset managers and the pension fund managers were making multi-month long adjustments to their positions that would inevitably have a directional impact on price. Sure enough a few weeks later the kiwi was substantially lower than post RBNZ and those traders who had the foresight and the patience to stay with the trade capitalized on the move.

I often say that day trading is for dopamine. We all want it. We all need it. But just like junk food it’s not really a recipe for long term success. Dollars are made on the Daily. It’s boring. It’s tedious. It’s certainly not sexy, but it’s where the real money in FX is made.


The Difference Between Trading and Investing

Boris Schlossberg

Contrary to popular belief you do not need to understand high level statistics or even be able to read a balance sheet in order to be a successful investor. Investing isn’t about numbers – it’s about narrative. How else would you explain a company like Amazon – a hybrid of Walmart and Federal Express – which is very good at selling dollar bills for 90 cents. Yet despite never making a dime Amazon’s stock has made its founder Jeff Bezos so rich that he can drop 250M on a vanity publishing project like the Washington Post.

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Apple on the other hand makes more money than the Medici but has seen its stock tumble by 40%. What is the difference? Its certainly not the numbers. Erase both names off the letterhead and set the pair of books in front of an investor and I am sure you would be shocked at what each business will be valued at in a private transaction. The difference is narrative. The Amazon story is all about how they will own the world of commerce, while the Apple story is that after the passing of Steve Jobs they have nothing new to offer to the world.

So narrative, not numbers drives investments – which is why some of the best analysts on Wall Street come from liberal arts backgrounds with degrees in such disciplines like Comparative Literature rather than accounting and finance. Any moron can build an Excel model whose investment worth is usually less than zero, but few can imagine the future. (see Tesla auto).

As human beings we love narrative. Storytelling is as old as the cave and deeply woven into our DNA. But as traders narrative can be our worst enemy. As traders we operate on a time frame where narrative can change in a heartbeat. Unlike investors who have the luxury of time on their hands to discover if their narrative thesis plays out as imagined, we – with our levered accounts and day trading focus – enjoy no such privilege.

Investing may be all about narrative, but trading is all about levels. Trading by its very definition is
the art of profiting from short term movements in price. Value means nothing. Narrative means nothing. Only price matters. And price is ultimately a function of levels. Are they broken? Are they supported? How much do we risk to find out the answer? Those are the only questions that should matter to us traders.

Don’t get me wrong. As a trader you should know your narrative. You should be keenly aware of all the macro and micro themes running through the market, if for nothing else than to know when to stand down. But as traders we cannot make the following mistake. We cannot enter into a trade based upon a price level trigger and then remain in it because we are convinced of its narrative truth.

Yet we all fall into that trap.

In one of the greatest movie lines of all times in The Big Chill Jeff Goldblum challenges Kevin Kline to find anything in life more powerful than rationalization.

Michael: I don’t know anyone who could get through the day without two or three juicy rationalizations. They’re more important than sex.

Sam: Ah, come on. Nothing’s more important than sex.

Michael: Oh yeah? Ever gone a week without a rationalization?

Narrative is what we use to rationalize our losing positions and as traders we simply can’t afford that luxury or we will go bankrupt.

The difference between traders and investors is that we trade levels, not narrative and we constantly have to remember that fact.