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Problems when entering into daytrading positions before news releases

One of the most common mistakes that is made by inexperienced traders can be seen when traders establish positions directly before major news or economic releases are made public. It is a commonly known fact that forex markets can be drastically influenced by news headlines or major economic releases. So, there are many instances where traders will set a position in the direction that the currency is expected to move once the release is made public. The main problems here can be seen when the consensus estimates by market analysts prove to be incorrect.

Hypothetical Example

“On the positive side,” said Jonathan Milet of Forexminute, “news events and economic releases can give traders some of the clearest market signals and guide trading sentiment for a full day—or even longer.” For these reasons, many traders try to jump on these events before they happen and place trades in the direction of the market’s expectation for the outcome of the release. For example, imagine that the your forex news calendar quarterly figure for the US Gross Domestic Product (GDP) data is scheduled for release today. Let’s say the market consensus (the majority of market analysts) is expecting these figures to show that the US economy grew at a quarterly rate of 2.5%, after a growth rate during the previous quarter which came in at 1.5%.

Since most analysts are expecting the number to come in positively (a positive rate and an improvement from the previous quarter), many traders might start to expect that this will be a positive day for the US Dollar. So, to capitalize on this, let’s say that we can enter into a sell position in the EUR/USD currency pair (a long Dollar position against the Euro). But while this might seem like a good idea on the face of it, there are some very clear problems that could lead to losses in these trades.

Specifically, there is always the possibility that market expectations are simply just not correct. This will be the case a good deal of the time and this could have a large impact on your ability to successfully trade your chosen currency pair. In the hypothetical example above, let’s assume that the actual US GDP number came in at 0.5% (instead of the expected 2.5%). In this case, the actual number would have come in well below market expectations and also at a slower rate than the previous quarter (in essence, a negative outcome in both cases). What would you expect the market reaction to be in these types of cases?

First, the market reaction will likely be drastic in the other direction. That is, the US Dollar would likely have a very negative trading day and there are two major reasons for this. The negative data print would be enough on its own to lead to some heavy selling pressure in the US Dollar (usually for the entire trading session). But, in addition to this, there will be many traders who made the mistake of entering into US Dollar positive positions and these traders will now be forced to bail out on these positions to avoid significant losses. This potential downside shows some of the risks involved when committing to trading positions before important data is released.

This was posted in Bdaily's Members' News section by Richard Cox .