We know that news creates volatility and strong daily moves, that is true, we know that markets tend to have flat days just before the news release day, and then on the actual release day they will move 1-2%, no surprise in that.
The big misconception among some traders, is that the news game is some kind of 50-50 probability bet, something like; ‘If news is good I will buy, if it’s bad I will sell.
The truth is that, the news factor is impossible to figure out, we only know it will cause volatility and strong daily move, but the actual probability of interpreting the news correctly is only 12.5% this is because you are actually taking a combination of 3 individual, 50-50 bets, so the resultant probability is (0.5 x 0.5 x 0.5) = 0.125 or 12.5%
Here are the 3 bets you are actually taking when gambling on the intraday news:
1) Will the news be positive or negative (compared to last time)? That’s a 50-50 bet
2) Will the news be better than analysts’ expectations? That’s a 50-50 bet
3) Has the ‘news’ already been priced in the markets? That’s another 50-50 bet
You actually have 12.5% probability to win, and a 87.5 probability to lose!
Ever heard the old adage, ‘Buy the rumour sell the news’? This happens all the time in the markets! Market volatility during news days is purely psychologically driven, and no one can predict how the collective mass of traders will react when the news is out.
In fact you are better off just fading the ‘news’ consistently, this way you will end up making money more times than not.
What I like about options and what I hate about Futures contracts, is that with options this kind of volatility doesn’t shake you out of the market unnecessarily, personally, I trade the markets on a swing trading principle, holding trades for many days, I know that a single day’s move cannot possibly change the daily trend, no matter how big it is, and when I trade using Futures, I have learned to do something counter intuitive, and that is use massive stop loss orders, proportional to the probability of the trade going well, they often can be 3 times larger than the profit objective (a risk reward ratio of 3/1). This may sound completely counter intuitive and like nonsense, but actual trading experience shows that it couldn’t have been otherwise, thanks to news-driven volatility, tighter stops won’t work. And everything you read about it in books certainly cannot be implemented in practice if you are a Futures swing trader.
I once applied for a Forex day traders job, the firm that offered this job had a fancy risk/reward system in place and required a minimum of 3 trades per day, after I presented them with the above facts they started second guessing their risk/reward ratio and the job requirements. I mean how can they ask for 3 trades per day, just for the sake of it? Risking an equal amount of money on every trade, on different probabilities every time?
And having the news factor kicking in once in a while, overriding everything else.
I am sure there are profitable Forex day traders out there, but they trade on simple momentum, no reason behind the trades, and their losses are largely due to the news factor, their profits on the other hand are too small when compared to a swing trading strategy, or even a simple strategy that holds overnight trades, let alone the many hours they commit to it. What this firm failed to realize, is that you just can’t apply fancy risk/reward theory to the markets, the system may be made profitable, but it will be severely underperforming a swing trading strategy that trades on probability and doesn’t miss overnight movements.
I stick to advice taken from Warren Buffet and Larry Williams, and that is:
Never invest without reason, and Don’t day trade.
Now with options trading, the trader has a big advantage, he doesn’t have to worry about large stop loss orders like I sometimes had, he can pick options to profit from minor price movement, such as tight price range, as well as options that allow him to capture large breakout moves, ones that show momentum. And of course he can trade the news-driven volatility with directionless option strategies.