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Reader Questions Answered

Entering Trading Positions Around News

Last week I took part in a Currensee panel discussion titled Scalper, Swinger, or Holder. The main discussion, as the name implies, was about trading time frames. Fellow panelists Mike Baghdady, Shaun Downey and I took several questions at the end. Here’s one we couldn’t get to during the allotted time, but I think is definitely worth a blog post here.

Would you prefer to enter into a trade “before” or “after” a NEWS event. Would it depend on how big of an impact that the news has on the market?

If you are a short-term trader, putting a trade on right before a significant news item is essentially the same as gambling. You’re putting your account at risk on what’s basically a coin toss. Traders are not in the business of taking blind risks. They look to repeatedly apply an edge to make money in the long run. For that reason, I’m in favor of waiting until the dust settles after the event.

As to whether it depends on the impact of the event or news item on the market, I would suggest being very careful here. We can certainly point out the major calendar items which will have the market focused on them (payrolls, central bank rate statements, etc.). There are a whole lot of others at the second level, though, that during any given period of time can either be very important or totally ignored. You need to be very well plugged into the market to know which are likely to create volatility on a given day and which probably won’t. And of course even a high profile release or news item might prove a complete dud. You just never know.

Now, if you are a longer-term trader then trading before a data release or news event probably isn’t going to matter much. It’s just a question of how much a potential adverse market move in reaction would impact your position. Of course, if you are a fundamentally driven trader, and the news event in question could alter your view, then you may want to wait to see the result.

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Trading News

New NFA Forex Leverage Limits In Effect Today

I wrote a while back (New NFA Retail Forex Leverage Restrictions) about new rules coming into effect from the NFA which limit the amount of leverage US member forex brokers are permitted to allow their customers. Those new rules start today. If you have a US brokerage account you have probably already received notice about the rules if your broker previous offered more than 100:1 leverage, which is the new cap.

Also, the margin must be calculated from the notional value of the position. I believe this has forced a change among some brokers who previously set their margin based on the size of a position rather than its value. For example, they would require $1000 margin on a 100,000 EUR/USD trade. Under the new rule they would have to require 1% of the value of the position be posted as margin. If EUR/USD is trading at 1.50, then a standard lot position would be worth $150,00, meaning a $1500 margin requirement.

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Trading News

New NFA Retail Forex Leverage Restrictions

The National Futures Association (NFA) is not well liked by many retail forex traders because of restrictions they put in place earlier this year.  You may recall my posts NFA rule which effectively bans the practice of “hedging”, NFA Justifications and Reasoning for Killing Forex Hedging, and New NFA Rule Impacts More Than Just Forex Hedging and all the discussions that went on around them (literally hundreds of comments). They forced some changes to the way brokers handle positions and transactions, and the way some traders did their thing (or forced them to switch their account to non-US regulatory coverage).

Well, in case you haven’t heard yet, the NFA is back at it.

Effective November 30 they will be requiring US-based retail forex brokers to cap available leverage at 100:1. To quote the notice to members:

“…beginning on November 30, 2009, all FDMs must collect a customer security deposit of at least 1% for the currencies listed in Section 12 and at least 4% for all other currencies.”

The Section 12 currencies are the majors and some of the big European regional ones: British pound (GBP), the Swiss franc (CHF), the Canadian dollar (CAD), the Japanese yen (JPY), the Euro (EUR), the Australian dollar (AUD), the New Zealand dollar (NZD), the Swedish krona (SEK), the Norwegian krone (NOK), and the Danish krone (DKK). The US dollar (USD) is not specifically listed, but obviously it’s included.

As I understand it, any pair which includes at least one of the above currencies is covered by the 1% margin rule (100:1 leverage). In other words, the Mexican peso (MXN) isn’t on the list, but USD/MXN would fall under the 1% margin rule because the USD is part of the pair. All other currency pairs fall under the 4% (25:1) rule.

Value vs. Size
Note that according to the proposed rule change that was sent by the NFA to the CFTC for approval (the latter regulates the former) the margin must be calculated from the notional value of the position. I believe this is going to force a change among some brokers who have set their margin based on the size of a position rather than its value. For example, they would require $1000 margin on a 100,000 EUR/USD trade. Under the new rule they would have to require 1% of the value of the position. If EUR/USD is trading at 1.50, then a standard lot position would be worth $150,00, meaning a $1500 margin requirement.

It’s Actually More Leverage
This rule is actually an expansion of permissible leverage over what the NFA had proposed back in 2003. At that point they wanted 2% for the Section 12 currencies. That would have only permitted 50:1 leverage, which is closer to what the futures market margin rates are at (though still well short). The members put up a fuss at that point, however, and got them to put a hold on implementation of the rule.

Higher Leverage Means More NFA Action Against Brokers
The rules change proposal noted above also indicates that brokers permitting higher than 100:1 leverage were more apt to be the subject of NFA and/or CFTC enforcement action. At the same time, the two NFA member brokers capping leverage at 50:1 were never the subject of such action. Oanda is one of those brokers. I don’t know the other.

The NFA has indicated that it is concerned about an increased account burn-up rate at higher leverage points. While leverage is only a tool, it’s clearly that it is a dangerous tool in the hands of many new traders, even more so when you consider that those brokers offering the higher leverage seem more apt to engage in shenanigans.

Actually, the NFA proposal letter notes that one broker who offers 700:1 leverage (yikes!) actually claimed that it allows customers to employ tighter stops. I know this may sound like a contradiction, but I’ve long held that tight stops are a trap (see Close stops do not lower your risk). This 700:1 broker should be shut down if it honestly believes that higher leverage is required for tight stops. What are they smoking over there? I’d love to hear the logic. It would no doubt be quite humorous.

My Reaction
I’m perfectly fine with this rule. In fact, it really has no impact on my own trading. I have long traded through Oanda with their 50:1 maximum permissible leverage and never found myself constrained. A great many experienced forex traders will likely have the same response as they tend not to trade at much more than 10:1 or 20:1 actual leverage.

Also, I think the 100:1 leverage keeps the spot forex market in a good competitive position vis-a-vis the currency futures market.

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Reader Questions Answered

The Timing of Data Releases

A question which recently came up had to do with getting data releases. A trader looking to trade the news noticed action in the market ahead of the major data releases thought that maybe some folks were getting the data earlier than others. On that basis he asked:

Is there some way to get these releases earlier?

To first address the timing of data releases, the news events of primary interest to traders are the economic data releases and such. Those things are provided to the news organizations ahead of time by the issuing institutions, but embargoed until the official release time. No one would dare release the data early as it could very easily cost them access to the release all together.

As to action ahead of time, since the data isn’t available to anyone outside the embargoed news groups, basically what you’re talking about is traders gambling on what’s coming. It happens more regularly than strikes me as being reasonable. I mean a trader can get really nailed if they’re in the wrong direction when a release comes out. Granted, it’s also possible to make a lot of money too. It really is just gambling, though.

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Ways to approach news events in your trading

A question recently came up in regards to the impact of news on trading performance. The questioner was feeling a bit overwhelmed with the idea of trying to deal with all of the different sources of potentially impactful news and information that hits the markets. Let me share some thoughts on the subject.

Firstly, I can completely understand how mind-boggling it can be. There is seemingly a constant stream of data coming out. Forex traders in particular see loads of it each day as the various major industrialized countries put forth economic data and have prominent speakers on the schedule. Then too there are any number of things that can crop up anywhere in the world related to gold or oil, for example.

Here’s the first thing I would say in that regard.

It is possible to narrow significantly the list of scheduled items that are likely to have a significant impact on the market you trade. Clearly, a stock trader has to worry about earnings reports, but retail sales data may be completely meaningless. A forex trader has to worry about things like trade, but won’t concern themselves much with corporate earnings. An interest rate trader will certainly keep an eye on employment figures, but won’t worry as much about the speech by the head of the European Central Bank.

The implication is that you can generally pick and choose the calendar events that you need to focus on for your trading. Of course there are always going to be surprise events that happen, but you can only deal with that though a generally solid risk management approach.

Now, once you have identified the data releases and other events that are meaningful to the market you trade there are three ways to trade in relation to them.

1) Take positions ahead of the releases, speech, or whatever.
This is basically gambling and not recommended.

2) Make sure that you are flat ahead of the aforementioned events.
For most short-term traders this is generally the best approach. It keeps one out of the wildness that can come with unexpected results. That volatility makes meaningful trading very challenging, and not very profitable for most people. The majority of folks are better off waiting to see how the market settles out afterwards.

3) Trade in a time frame for which the kind of intraday swings created by news events are of no significant impact.
This generally means taking on positions with relatively wide stops that are expected to be held for at least several days, if not weeks or more. The approach here is to play the bigger price movements with the view that intraday swings are just blips.

You personal trading style will dictate the approach you take.

One other thing I would add in comes in the area of trading systems and their performance around news events. If a system has been tested over a sufficiently large data set relative to the time frame it trades then that means it would include any number of data releases and other news items, and thus their impact on prices. As such, the user of such a system, if the performance is deemed solid, should not concern themselves over much with releases. They are, essentially, factored in to the system’s performance.