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.

RBNZ.Example

NZD/USD – 100 pip Reaction to Dairy Auction?

NZD/USD – 100 pip Reaction to Dairy Auction?

Chart Of The Day

Fundamentals

Tonight’s Dairy Auction in New Zealand could have a significant impact on NZD/USD. Over the past 2 months, dairy prices have fallen 20% and since milk represents 30% of New Zealand’s exports, the decline in prices is expected to restrict the country’s terms of trade and possibly even slow the central bank’s pace of tightening. The last time the auction took place on April 15th, NZD/USD reacted very negatively to lower prices and lower volume. Over a 72 hour period, the currency pair dropped from a high of 0.8690 to a low of 0.8560. A very similar reaction was seen after the April 1 auction, with NZD/USD dropping from 0.8670 to a low of 0.8515 on the back of lower prices. If tonight’s auction yields similarly disappointing results, it could reverse the rise in the New Zealand dollar and drive the currency pair below 86 cents. On Wednesday RBNZ Governor Wheeler will be speaking about “The Significance of Dairy to the NZ Economy” and there is a very good chance that he will use this forum to signal a slowdown in tightening. If we are right, there could be a nasty correction in NZD/USD. Of course if the results of the milk auction is strong, a relief rally in the currency could take it to new year to date highs.

Technicals

The NZD/USD chart highlights the currency pair’s move after recent dairy auctions. On a technical basis, higher lows and higher highs signal strength for the currency but 87 and 8750 are significant resistance levels for NZD/USD. If both levels are broken it should be clear sailing up to 8845 but if NZD/USD fails below 87 cents, a drop to 86 becomes likely.