23 December 2022

Reactivity of the Forex Market to News Events

Is there is a decay factor in the way a market reacts to news data, is there a way the reaction may be increased ? This is a way of looking at market as dynamic and affected by news inputs but with a logic of their own. So when trading them, it needs to be considered whether the market will react in such a way to a news event (the projection) and whether it can react in such a way (for example elasticity) and also whether there is a logic which will simply take the news input and work it another way, rather than the expected outcome.

Simply put, the market often does not react in an expected way. In fact it often does not react in a tradable way, it oscillates: from a given direction (perhaps the expected direction) to return to where it was, more or less. However it may the case that this intitial reaction, perhaps in a minute or even less, was a pointer to the way the market will move. This would seem to be a case of that the market logic is congruent with the reaction, but it cannot react in such a way immediately. This market logic is composed at least in part of the varying aims and beliefs of both human traders and computer programs. This outcome may not be much use in news trading but can be helpful for longer term trades.

The alignment of market reaction, elasticity and logic which can produce a significant directional move rapidly, is a kind of the holy grail of news trading, but it not necessarly likely to happen, as it takes a lot for the ducks to get in a row. A contingeny is typically surprise, and this is inherently a difficult trading situation, as it is the unlikely, unpredictable outcome. It tends to be more than surprise, there may also be a kind of boost in terms of emotions such as fear and optimism driving such a move, that is the expectation landscape is changed by a piece of major news, which allows a more elongated reaction.

Trading into the news can be trading into volatility

This is why FOMC and NFP are important, as they can in certain situations reorient the economic and trading predictive framework which traders will tend to use (for example value levels). This means that such moves may tend to place the market into a new value range, instead of setting the market up for a reverse as volatility declines (i.e. it is pulled back to where it was, which can happen with moves which suddenly spurt upwards or downwards). The extent to which traders are following the market or creating the market en masse is perhaps less important at the moment of news release, but can become more important as the time after release increases.

This lack of apparent control is a feature of news trading, and is why traders may prefer to stay away at such moments. Indeed it is a moment where guessing comes into play, in a way it would not be utilised in other times. There is insufficient technical activity on which to define and plan a move along with fundamental data which is supposed to be innacurate if the market is to react in a desired way (or at least react).

However a trade can be be hung around some kind of analytical view which suggests that the market will react in a certain way. There are moment when the market reacts and reacts as expected. An example is when the Fed started raising interest rates after a long pause. The sheer shock of this event, even though expected and supposedly priced in, still produced a sharp value change.

But even here, there is intense uncertainty, as the expectation would be against such a move, as it was expected. So there is more than expectation and suprise, there is a market reacting because it can. And arguably the surprise is hidden in but existing in this moment as well, as the market itself and its particpents react to the reality of a sea change in value expectation.

This idea of an expectation in the present, but the suprise realised in the reality of a change in future value expectation, is what an oscillation is not. This is because an oscillation is a suprise which does not have a future change in value expection embedded within - it reacts in a directional way, but there is no belief to sustain it. The news conference after FOMC can provide a structure to more firmly enable an expectation change or reverse it, which is why there can be sometimes significant changes in value during the news conference.

The kind of action the Fed took during the long period of low interest rates, was based around matters such as quantitative easing. This has a complexity to it, which the news conference needed to extract. Now that such stimulus has ebbed (for now) and the need is to restrain inflation, the headline Fed Funds figure comes back to the fore, suggesting that a different landscape may emerge, maybe more like it was before 2008.

However the particular nature of the efforts being made now, to restrain inflation and reduce the chances of a recession, suggest that there may be a reactivity to the market all of its own. One can wonder to what extent the years of stimulus has lastingly affected the market and how efforts to dampen down inflation now (and avoid a recession) can restore the way the market was, more resilient and less prone to collapses because of interest rate changes.

It is still risk on/risk off as can be seen the way riskier market are more obviously affected by these Fed decisions finding lower value ranges, but perhaps there is a way for the market to find a logic which moderates these extremes and lets it grow again. For a growing market is a way to help avoid economic collapse, as it was during the long years of stimulus and low interest rates.

Where does the Forex market fit into this, perhaps more as a pointer towards market 'health', in the way it can react to macro changes in economic policy. However from a trading perspective, it might be suggested that the decay factor may diminish and the capacity to react may increase, to answer the quesion posed at the beginning of the article. That is excessive oscillation may be a reflection of an unhealthy market, while more directional or structured reaction can be reflection of an unhealthy market but also may be contingent on a market structure and function which has less extremes of conditions. Such things are the basis of an almost algorithmic reading of the market - if these factors exist then a certain statement can be made, without worrying why such a statement can be made.

But what information can be gleaned from such a statement. It is one of many market statements which are interesting (potentially) but do not help in a trade, that is there is no tradable information content. This is because all information is quickly digested but generally with non-predicatble outcomes in terms of direction - this is the very basis of news trading and why it becomes a guess, or close to a guess. In news trading, to an extent is the essence of a trading market. However trading patterns exist on top of such moves, and provide a way of managing a trade, on longer terms, but news trading does not tend to have this relief, which is why it is so unpreditable and volatile.