Fundamentals 101: Tradable or Fadable?

Dear traders,

How true is the statement: “Good news? Long. Bad news? Short.”?  Why do prices plunge when news is bullish, and rally when news disappoints? 

This primer answers all the questions with regards to price movements in relation and most importantly, in response to fundamentals, headlines and economic data releases. Fundamentally poor or newer traders get a focused, no-frills primer on only the most important economic events to keep an eye out for to improve efficiency and proficiency. 

It sheds light that traders do not need to feel obliged in choosing a side, whether to trade by abstract technical levels, or logical economic releases. Traders are in fact entitled to enjoy the best of both worlds by employing Technical Analysis to get high probability trades with accurate entries, while leveraging on Fundamental Analysis to get high-yielding, explosive trades in a holistic, synergistic approach. Includes a strategic, easy-to-replicate risk-management approach that can be applied even in the most stressful of economic releases.

Good news, long. Bad news, short.

Call it bad trading, call it naiveté. Hate to admit it, but once was a time that I believed in it with my life. After all, news doesn’t lie. Right? 

“I’ll just be there for EVERY news event, EVERY data release, and trade in that direction. EASY pips.” – Yours Truly

It soon dawned upon me – it seemed lesser and lesser that that was the case after crashing my first account. Woe is me! If only trading was that simple! If only life was that easy…

Event traders applying the blanket logic of “Good news, long. Bad news, short” tend to have an equity curve with a high standard deviation, and often suffer from losses as a result. Similar as it is in real life, rarely do consequences ever tend to be linear and absolute in trading. Just like how we practice tactfulness in our day to day affairs, likewise, there’s no reason for us to renounce wisdom when it comes to trading. Considerable proportions of versatility is a prerequisite for successful analysis of the financial markets, all in the name of consistently profitability.

The pivotal question whenever we trade an event or data release isn’t whether the actual result has beaten the market forecast or expectations, but whether the piece of news is tradable or fadable. Simply put, we are putting our focus on whether that particular piece of information is likely to generate continuity in price or would it be more likely a catalyst for correction? 

Simple as this may seem, it lies at the heart of the reason why trading is such a demanding (yet rewarding) task. Many psychological factors are put into place, with the more sophisticated hedge fund managers acting on the rumour and taking profits on news, every moment in the market is unique in its entirety. This therefore implies that profits will elude traders applying a blanket universal approach in their trading.

Being the only Economics major in my circle, it’s sad to point out that I’m the only one amongst them to pay any attention at all to headline events, fundamentals and data releases. And I don’t blame them. Most of them are Engineering majors swearing by a solely technical approach, love nothing more than to gleefully rub in my face how optimistic releases often lead to sell-offs and how unfavourable news leads to rallies. They would go on to conveniently conclude that news is therefore, worthless. Quite often they are right. 

With most technicians end up fading the killer spikes accompanying a favourable economic data release, price eventually retraces to profit-taking and they’re able to clock some quick pips. However, they will rue the day they’re wrong, when price crashes through their position like a bus, and all they can do is stare as losses stack by the second. Horribly awry.

In my humble opinion, trading solely by technicals in itself is limiting and ineffectual in the long haul. It’s like driving a car by only looking at the rear view mirror – only looking at historical happenings, if you will. When driving, we always gather information from both the back and front – why trade differently? The future isn’t set by just candles on the chart. It’s dictated by headline events, news, fundamentals. However, candles DO often determine the impact of said news. 

Bad news after an extended sell-off usually has little follow through and frequently results in a surprise rally as profit-taking and short covering takes over. Good news could also fail to produce additional upside if price momentum is already indicating a momentous bull run. With the parameters in place, we go back to the million-dollar question. Tradable? Or Fadable?

I have a checklist I go through before partaking in an event trade. It is by no means an exhaustive or definitive fundamentals guide, but it might help you create your own model. 

How important is it?

I cannot emphasize more on the importance of understanding what matters to the market and what doesn’t. For instance, the importance of US Wholesale Inventories pales in comparison to Non-Farm Payrolls. French m/m Consumer Spending is far less market moving than the German IFO Business Climate Index. When trading events, focus ONLY on data that make a significant, lasting impact. These are the most important economic releases you should keep your eyes out for, at least when trading G10 currencies. In no particular order;

• Non-Farm Employment Change [Employment]
• Unemployment Rate [Employment]
• Non-Farm Payrolls [Employment]
• Average Hourly Earnings [Employment]
• Gross Domestic Product [Domestic Economic Development]
• Trade Balance [Domestic Economic Development]
  Institute for Supply Management (ISM) Manufacturing Index [Manufacturing Segment of the Economy] 
• Purchasing Managers Index (PMI) [Manufacturing Segment of the Economy]
  Consumer Price Index (CPI) [Inflation Gauge]
• Producer Price Index (PPI) [Inflation Gauge]
  Information and Forschung Institute for Economic Research (IFO Business Climate Index, IFO Report) [EUR Economic Activity]
• Japanese Tankan Sentiment Survey [Affecting Japanese Economic Policy]
• University of Michigan Consumer Sentiment Index [Consumer’s Attitude of the General Economy – Will affect their spending]
• Retail Sales
• Interest Rate/Cash Rate Decisions
  Central Bank Announcements 
• Central Bank Minutes 
• Statements of the respective monetary officials 

To what extent is the surprise?

The catalyst to volatility is dislodgement. Price movement happens when equilibrium is disrupted. The bigger the surprise, the greater the disruption, and we have a higher probability for further price action.

What has the price been doing?

Did price rally into good news? Sold off into bad news? The pivotal concern is determining how much of the release has been priced in or anticipated. The more extended the move before release, the greater the need for a monumental surprise to warrant price moving along its current direction before the release.

What’s the headline?

Easy you think, but in fact deceptively challenging. You can have the stars align on an event trade and still come out short if some other piece of news that slips through the crack proves to be more dominating. Organisation of the Petroleum Exporting Countries or OPEC headlines are a common elusive. For instance, a positive economic surprise out of America may have no impact on the greenback on the day that Moody’s announces that all of North America is going bankrupt and American banks are left holding the bag. Sounds familiar? We might well have something similar now, with all of Trump’s chatter about the economy being bullish while the yield curve stays flat. I believe in the statistics of course, a lot more than Trump.

My point is, if a tug exists between the micro and the macro, the macro will win every time. Not everything is about mean regression. That is why news matters. It’s good practice to scan headlines from Bloomberg, Dow Jones, Telegraph, Guardian, London Times, and have CNBC on stream to get a grasp of the day’s dominant headline before starting your trading day – to identify possible potential blowouts. Yes, my Bloomberg subscription is in fact an insurance against any potential losses from my possible lack of, or lapse of real-time knowledge. In the game of fundamentals, knowledge is power, but real-time knowledge is KING.

The best trades, for me at least, tend to be negative economic shocks after a prolonged rally. Price plunges faster than it ever rises. It’s easier for trust to be lost than gained. It helps too that the more sophisticated money managers tend to be more cynical. That is why event driven short trades bank the fastest pips. Of course, the converse could also lead to big trades – positive economic surprises after an extended downtrend, albeit not as fast, but pips are still pips. The greater the equilibrium distortion, the greater the probability of a continuation move. The best setups are most elusive, but also the most rewarding. Ergo, it pays to struggle with the barrage of data day in day out, to draw the best analytic conclusion. All in the name of profitability. 

Checklist

In addition to the above checklist, I do employ technicals as well when trading events. Some final things I check before pulling the trigger are as follows;

1. Confirmation on the 5 minute chart 

If I’m bullish after the news I want to see a white candle close before pulling the trigger. I’ll refrain from the trade until it happens. Likewise for black candle closes when I’m bearish. This is a simple way to determine what the market is feeling at the moment, yet not at a time frame where you would be too behind to take the trade.

2. The Cream is in the Cross

If news dictates UK/NZ/AUD to be positive or negative, I try to conjure the trade in a cross in order to minimize dollar impact. This is to eliminate dollar flow pollution. 

Take for example, news may be EUR positive, but in a risk averse economic climate, EUR may lose ground against the greenback, but would gain so much more against JPY. Trading the cross reduces your exposure to a sudden sentiment change and grants you a purer position when trading events.

3. Trade in Pairs

A common routine I do when trading events is to trigger dual executions. The TP of my first execution would be at 2/3 the risk (if I’m risking 30 pips, my TP1 will be at 20 pips). The other execution at 1/3 risk won’t have a TP, but will be appropriately trailed on the 5 minute chart by using our proprietary ecs.ATR pivots, ecs.Camarilla and 15-minute Murrey Math levels. Or you could use the ECS Swiss Army EA for a more automated approach. I prefer to do it on MT4 manually. CAMMACD.ContrarianScalp or CAMMACD.CSS template is good too. 

Idea is to keep the winners flowing, we’ve no idea where a trade could take us, but there’s no reason to stop profits coming in too. Keeping the second trade alive captures the full range of movement and nets you a ton of excess profit over time.

So that’s my primer to fundamentals and event trading, and in determining whether a pair is tradable or fadable. Of course, to do it with finesse requires countless hours of conscientious practice and insurmountable amounts of homework. Crux is to understand first the story, then undertake the trade. 

Good trading,
Davin Wu
Trader & Analyst