How significant is following the news for forex trading?

How significant is following the news for forex trading? by Laurent Bernut

Answer by Laurent Bernut:

I know two types of traders: those who trade the newsflow and those who make money. 1) How the brain perceives news 2) What news matters and what does not and how to know which is which 3) Stop Loss and newsflow

1. The engineered poison of newsflow: Mice on cocaine, fight flight or freeze

A. Play this game to know how brainwashed You really are

Every day, write down whether you agree with the market comment of the chrematocoulrophone (1) “du jour” on Bloomberg TV. They do a superb feat. When market tanks, they dust off some perma-bear and when markets roof it they fish out some perma-bull. Those financial jesters (1) perfectly rationalise what is happening.

Now, take a piece of paper and write whether 1) you agree with the dude 2) whether he is bull/bear. At the end of the week/month, line up agreement and compare the results with your bullish/bearish view of the world. This is confirmation bias in real time.

B. How the brain perceives news

I want to be the first subscriber to a news channel that reports financial trains arriving on schedule. Currently, financial trains have to either beat their consensus timetable or derail to show up on the news. Until then, Disney Channel is good

News is engineered to elicit reaction: sell paper, trade. It activates the mesolimbic reward circuitry (think mice on cocaine) and/or the stress response: fight, flight or freeze. It is crafted to be sensational. The brain picks up on the noise, the flashes, the tone of voice (try and speak like a newscaster to your friends and see how weird it actually sounds)

The problem with either brain trigger is that it distorts reality. Reward circuitry is dopamine which creates cravings, hence the strong addictive mechanism. This is the euphoria superman drug. Bad news for risk management

The stress response releases a powerfully corrosive drug named cortisol that kills libido, constricts bowel movements, triggers panic attacks and inhibits the pre-frontal cortex, otherwise referred to as the thinking brain. So, Yes, science says that being glued to the newsflow actually makes You dumb. Two ways to prove it: anyone who has been on a trading floor when there some “major news” breaks out knows what i am talking about…

More importantly, when you unplug from the matrix, isn’t your thinking any clearer ? You start to have ideas, think more strategically. The brain fog dissipates. This brain fog comes from staring at the newsflow all day.

Newsflow is literally neurotoxic

2) News that matter, those that don’t and how to spot them

Here is a simple test to assess whether news and more importantly their source have worth following:

1. news can reverse a trend: if any news does not have the power to stop and reverse a trend, then it has no market impact
2. Persistence: some news cause knee jerk reactions, but then trends resume their course as if nothing happened.

So, in terms of importance, these are the 3 major news that we follow each month

1. FOMC: everything in the world is priced of the US 10 year bond. In December, when the Fed raised rates, January was not a happy month…
2. BoJ: October 2012, Bank of Japan decides to debase its currency. It did impact not only Japan but the rest of the world
3. ECB: has diminishing persistent impact
4. Pegs: The Swiss have done a great job at fending off “evil speculators”. Brexit too. We have currency peg alerts on Google, but we stay away from pegged currencies such as HKD, HUF etc anyways

The rest, whether it is non-farm payroll, CPI, PPI, MoM retail numbers, consumer confidence survey, housing starts, inventory or tea leaves expert forecasting, all this rarely elicits anything beyond: “yeah, yeah, pass me the salt, please”. There is immediate market impact, but no trend inversion and no persistence of signal.

Useless does not mean worthless. It means those indicators will be baked in the thought process that will ultimately lead to the decision on rates. They are important components, like the windshield on your car, but what You care about is your automobile, not its parts

3) Stop Loss and news

Beginners want to stay in control. Veterans know control is an illusion. Beginners like to keep a tight leash. Veterans allow markets to breathe. Beginners’ tight stop losses get tripped all the time. Veterans love their long lunches…

Tight stop losses means bigger positions. Combine this with crushing leverage and this is a recipe for a toxic neurococktail: cortisol is a powerful chemical that numbs any pains. It is present in all traders experiencing high stress and in harmful concentration in those who blow-up. Game Over

Forex seems to have more randomness than other data series (at least those i have worked on) on identical sub 30 mn periodicity. I don’t know why and it is irrelevant, frankly. What matters is how the noise gets cancelled in the order management logic.

To that effect, i am the proud inventor of French Stop Loss. We follow a scale-out/scale-in model. Rather than anchoring all stop losses on the latest position’s stop loss, we use the one prior (+ a cute little zest “bien sur”). This gives a lot more wiggle room to positions. Cons: This reduces position size and performance acceleration, Pros: this reduces the number of stop losses, increases win rate, lowers avg loss. Bottom line, this stop loss method is fashionably late, hence French Stop Loss, of course

The point of that digression is that allowing the market to digest knee jerk reactions to news materially increases trading edge

Conclusion

We have three configs for our risk management: autopilot, monetary cavalry and Elvis. Autopilot is our standard config. It is on except for one week every month

Elvis does exactly what it says on the tin: rock n’ roll… Our metric is reproduction rate. Our units are Buffets and absolute. But, damn, those valleys are a seriously bullish signal for the adult diaper industry

More importantly, monetary cavalry is named after the main central banks. The week they come up with some announcement, we tighten risk. This is the only type of news where we take action to reduce risk. Sometimes we end on the profitable side of things, and sometimes we don’t. We have made a conscious decision to earn a little less than we could, because we do not want to lose a lot more than we should, and neither should You

How significant is following the news for forex trading?