Understanding Straddle News Trading and Why It Doesn’t Work and What to do Instead.
What is Straddle News Trading?
Straddle news trading involves placing two pending orders—a buy order above the current price and a sell order below the current price—prior to a major news release. When the news is released, the expectation is that the market will react strongly, triggering one of the orders and leading to a profitable trade. Traders often use this strategy during high-impact news events, such as central bank announcements, employment reports, and GDP releases.
Why Straddle News Trading Doesn’t Work
- Slippage: One of the main reasons straddle trading fails is slippage. During major news releases, market liquidity can dry up, causing significant slippage. This means that even though your order is triggered, it might be executed at a much worse price than expected, reducing or even negating potential profits.
- Whipsaws: Markets can be highly volatile and unpredictable during news events. Prices can spike in one direction, trigger your order, and then quickly reverse, hitting your stop-loss. This whipsaw effect can result in quick losses and make it challenging to manage risk effectively.
- Broker Limitations: Some brokers may widen spreads or restrict trading during major news events, making it difficult to execute straddle trades effectively. Increased spreads can lead to higher costs and reduced profitability.
- Lack of Directional Bias: Straddle trading relies on the assumption that the market will move significantly in one direction following the news. However, this is not always the case. Sometimes, the market may react minimally or move in an unpredictable manner, resulting in both orders being triggered and potential losses on both sides.
- Overheads and Commissions: Frequent trading, especially during high-impact news events, can result in high transaction costs due to spreads and commissions. These costs can eat into profits and make the straddle strategy less viable.
Transition to a More Reliable Strategy: Identifying Price Continuation
Given the limitations and risks associated with straddle news trading, a more effective approach is to focus on identifying whether the price will continue in the direction of the initial move following a news release. This approach allows traders to capitalize on sustained trends rather than short-term, unreliable spike. Below is a detailed trading strategy to help you identify and trade price continuations effectively.
Trading Strategy for Major Economic Releases
Step 1: Analyze Central Bank Priorities
The first step is to understand what data points the relevant central bank is currently focused on. For instance, if the Federal Reserve or the Bank of Canada is focused on GDP data, then the GDP report will have a significant amount of volatility because the central bank is in some way basing its interest rate decisions on that data release. To quickly determine the central bank’s current focus, you can use our Professional Economic Calendar, which includes a fundamental guide. This resource helps traders stay updated on the data points that matter most to the central bank, providing a strategic advantage.
Step 2: Use High-Low Expectation Forecasts
Professional traders rely on high-low forecasts to gauge market expectations accurately. Here’s a more detailed look at why these forecasts are crucial:
- Institutional Forecasts: Professional economic calendars include high and low estimates from top institutions. This broader range of expectations offers a more comprehensive picture of potential outcomes.
- Market Shocks: When a report exceeds the high estimate or falls below the low estimate, it’s a huge shock to markets because no analyst expected it. Such deviations often result in sharp market movements.
- Lightning Bolt Feature: This tool immediately signals a deviation above the high or below the low of analyst expectations. When a deviation occurs, the lightning bolt feature alerts traders instantly, allowing them to act without delay. The quick reaction to unexpected data can be the difference between a profitable trade and a missed opportunity.
Understanding High-Low Forecasts
Economic forecasts are derived from surveys of credible institutions, each providing their best estimate on upcoming data points. Retail calendars typically present the median of these estimates, which can be misleading. The median forecast doesn’t reveal the full range of expectations and, therefore, doesn’t indicate how surprising an actual data release is compared to the extremes of analysts’ projections. In contrast, professional economic calendars include both high and low estimates. This additional information shows the analysts’ expectations at the extreme ends of their projections. Great trading opportunities arise when data releases fall outside these high and low estimates, creating market shocks that move prices significantly.
Step 3 - Choose the Most Volatile Instrument to Trade
Using insights from institutional reports, traders can select the most responsive currency pairs. For example, if USD/CAD is particularly sensitive to economic data as outlined by the City Economic Surprise Index and the GDP report shows a significant deviation, this pair could be an ideal target for trading.
- City Economic Surprise Index: This report identifies currency pairs that react strongly to economic surprises. It highlights pairs that are sensitive to data deviations, helping traders focus on the most responsive markets.
- Risk-Reversal Report: This report shows market positioning, revealing a buildup of call or put options on certain currency pairs. Understanding these positions helps traders choose a pair that may have orders susceptible to getting liquidated upon the release of an economic data point.
- CFTC Report: This report details hedge funds' positions; if a lot of big players are long the USD/CAD but then data comes out against the CAD, some of those funds might have to unwind their positions leading to an outsized move. Good thing you didn’t trade the GBP/CAD.
Trade Execution Steps
- Confirm Central Bank Focus: Ensure the central bank is currently emphasizing the economic data in question. If the data is a primary focus, the report will have a higher likelihood of moving the market. Remember, if the central bank is focused on the data point, it’s because they are using that data point to make a decision on rates. This is the reason data points that are focused on cause volatility.
- Check Forecast Ranges: Before the data release, review the high and low forecast expectations for the event. Plan to trade only if the actual data significantly exceeds the high estimate or falls below the low estimate. This strategy ensures you act on genuinely surprising data and there will most likely be a follow-through reaction.
- Monitor Revisions: Check for any conflicting revisions in the data, as these can alter the initial market reaction. Make sure the primary release and any revisions align to support your trade.
- Enter Trade Promptly: Once you confirm the deviation, act quickly to enter your trade. Enter within the first 30 seconds. Speed is crucial, as market reactions to significant data surprises happen rapidly.
- Set Stop and Take Profit:
- Stop-Loss: Place your stop-loss below the low of the initial spike candle to protect against adverse movements.
- Take Profit: Aim for 30-100 pips for tier one events, adjusting based on market conditions and volatility. (Note: For tier two events, aim for 15-30 pips.)
Managing the Trade
- After the Initial Run: Look for a shallow pullback around a 23% Fibonacci retracement or near support/resistance levels. This initial pullback can provide an opportunity to enter the trade again after you’ve taken a few points off the table after your first entry.
- Break Even: Move your stop-loss to break even as soon as possible to protect your gains. The stronger the release, the shallower the pullback. Moving to break even is essential because the market should want to buy off your S&R level and continue to the highs of the one-minute candle and break. If that doesn’t happen, something could be off.
- Reentries: If your initial position is stopped out at break even, consider reentering at deeper retracements, such as the 38% or 50% Fibonacci levels. Use nearby support and resistance levels to guide your reentry points.
Conclusion
Straddle news trading often fails due to factors like slippage, whipsaws, and broker limitations. A more reliable approach is to focus on identifying whether the price will continue in the direction of the initial move following a news release. By following a detailed trading strategy that includes analyzing central bank priorities, using high-low expectation forecasts, and choosing the most volatile instruments, traders can better capitalize on sustained trends rather than short-term volatility spikes. This approach helps to manage risk more effectively and improve the chances of profitable trades during significant economic data releases.