News Trading Guide Series 2 - When Deviation Goes Wrong

This series reveals factors and deep secrets why you should not depend SOLELY on the outcome of a news event to BUY or SELL because of certain factors that makes deviations useless whether they are met or not.....

One of the major key decider to BUY or SELL after a news release is the DEVIATION. The deviation is the difference between the FORECAST & the ACTUAL result. The outcome of the measurement of the difference of the actual result to the forecasted deviation is what triggers either a Spike (extreme sharp movement), Slow Action, No Action, or Delayed Action. So it is expected that when a deviation is met you take the next action, but this is not true all the time time. See real scenario below:

On 12th March, 2015 the market waited eagerly for the US Core Retail Sales news release. The previous figure was -0.9%, and the forecast was 0.6%. The deviation was 0.5%, meaning that the USD should be sold if the result falls 0.1% lower or the USD should be bought if the results is 1.1% or higher. Economists were of the view that the result would be positive taking into consideration the good outcome of the NFP, which took place 6th March 2015. This is true since both components are correlated. However the results came at -0.1% and previous figure was revised downward to -1.1%. This was an extremely negative result for the US Core Retail Sales m/m and our best guess is SELL the USD but that decision didn't go well. See what happened below.

The above illustration do not occur always but lots of traders especially retail traders are victim of this, and many never know what went wrong. A clear deviation against the USD went the wrong direction.

CAUTION: Do not react too quickly to a news release....

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How Is Deviation Derived
Deviation is sometimes derived through a broad survey of a fundamental component like spending habits or job availability from economic experts, financial institutions, stores, consumers, manufacturers, e.t.c. The data collated from these survey is statistically computed to derive a possible deviation. Deviations are also derived from the collation of previous actual results of an economic event against the forecasted figures over a period (monthly, quarterly or a timeframe determined by the issuing financial authority).

How Deviations Are Used In Making Trade Decisions
It's simple as BUY/SELL when a deviation is met or exceeded.

For example: 
March 6th 2015 - US Nonfarm Payroll Employment

Trade Decision Formula
BUY = Forecast + Deviation = 311K and above (result is bigger than the previous)
SELL = Forecast - Deviation = 171K (result is smaller than the previous)

See outcome below (Actual = 295K)
US NFP March 6th, 2015
In most cases when the Actual is considerably bigger than the Previous figure but not equal to the expected deviation, the market still reacts. Even at 1% difference in some cases market can overreact. This is common for very high impact news release.

CAUTION: Do not focus or trade any news event that has a statement or press statement few minutes or immediately after the news release. Speeches especially statements from Central Bank's Governors can cause the market to react and reverse or continue it's momentum. A particular news release from the UK came out bad, and the GBP fell immediately but rose up sharply few minutes during Gov. Carney's Speech after the rates were released. Lot's of traders got stopped out with losses.
NZD Cash Rate Actual Result did not meet Deviation of 3.75% to BUY or 3.25% to SELL
Reaction of Gov Wheeler's Press Conference despite a stalemate in the actual result

Deviation Met But Market Moved Wrong Direction - What Went Wrong?
Like i said earlier that the deviation could be met but the market still moves to the "wrong" direction. The following reasons explains why this happens:
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  1. Contrary press statement overruled the actual results or painted a positive outlook on the currency. In some cases we have seen press statements that gives hope of a perceived failing economy or intention to hike rates, and since this is coming from the highest authority, investors are keen to change their minds.
  2. Insider tricks by government and financial bodies. It might surprise you but this happens. There was a time that the figure for a very high impact news release came out negative for the US. Few minutes later the market rebounded sharply in favour of the USD, and we found out that the results were changed citing reasons that the released results was not correct. Of course you can bet something funny must have happened!!!!!. Also there are bigger financial investors who are privy to the result before the result. They are capable of spurning the market to go one side, and then chop off their positions through counter trades.
  3. Revisions. This is very common and usually causes serious market counter reaction despite the actual result being released.
  4. A strong psychological confidence on a currency can cause the deviation to hold less meaning.
  5. Future expectation of a currency's value or economic outlook. If for example the European Union has agreed to tight rates or announce a date for QE then the deviation of the news release against the upcoming action would be meaningless.
  6. Mixed actual results from multiple news event. For example the deviation to BUY the CAD Employment Change might be met but if the CAD Unemployment Rate is extremely poor then a negative reaction might occur.
These are some of the reasons why deviations can mislead. It is very important to understand the dynamics, politics, and pulse of the market during news trading. A lot can happen right under your nose without your knowledge, which can be very devastating.

How To Protect Yourself
  1. Always use stoploss
  2. Do not add to positions excessively even while the deviations are met.
  3. Always watch out for revisions as they can cause serious counter reaction.
  4. Do not trade with too large volumes especially for account with high leverage.
  5. Take your profits quickly or use trailing stops

While all the above tips would help there are still situations beyond your control because of the big personalities involved in news trading that has the power to turn things around

We appreciate sharing your experience on issues like this on our comments column. Wish you success all the way.

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