Trading Risk Events can be a very profitable form of trading but you need to know how to do it correctly. In this Wiki, we are going to explore exactly How to Trade Risk Events so that you can understand how these concepts can apply to your trading.
This Wiki is part of our Fundamental and Sentiment Trading Strategies Wiki. Be sure to check that out HERE.
How to Trade Risk Events
Day trading is a very good way to find consistent trades that have a high probability and that require smaller stop losses. However, the downside is that you have to be at your trading desk most of the day to find them. This can get very tiring very quickly.
There are other day trading strategies that you can use to find better opportunities days and sometimes weeks in advance. This is the concept of trading risk events.
A risk event is basically any economic release or announcement that is scheduled on the economic calendar that has the potential to be a high impact event. Not all risk events are created equal and some do not move the market even 1 pip while others have the entire trading world in anticipation for days on end leading up to them.
This strategy relies on knowing which risk events to trade which will come through experience but you can shortcut this by following along with the daily analysis that some of the more premium news feeds offer. In that analysis, one of the biggest points is to highlight the tradeable risk events that you should be focusing on. You will also notice that a huge part of the news feed revolves around planning these risk events each day.
What is the process for trading risk events?
There are two main ways to trade a risk event:
Trading into a Risk Event
We trade into risk events because this is generally how institutional traders trade them. Many people imagine risk events to be chaos and visualize trading floors in utter panic with everyone running around trying to react to the headline number as it's released with huge amounts of money being made or lost. On some trading floors, this does happen but only on huge and particular events such as the hotly anticipated NFP figure or a surprise interest rate move by a central bank. Generally, risk events are traded in a much more controlled manner with careful planning and pinpoint accuracy regarding entries and exits.
Let’s understand exactly how this works by looking at some examples of how these risk events play out.
First of all, traders will look at the economic calendar and the expected forecasts for the following week on Friday afternoon. This allows them to see what risk events are planned and most importantly how the economists and experts anticipate the results of the releases. Some show a better reading than the previous release, others show a worse reading, and some forecast no change at all. Traders will then use that information to tie it in with the bigger picture.
For example, if we have UK average earnings next Wednesday and it is expected to be much better than the prior reading, and we also know that the BOE have made average earnings one of their key focuses in deciding whether or not to hike their interest rates, it is likely that the market will start buying the Pound into that risk event because it’s expected positive and this makes it more likely that the BOE will hike their interest rate sooner.
The big picture is very important when deciding to trade into a risk event and the general rule is that we need to have market expectations match the overall picture for that currency. For example, if the event is expected to come out better than the previous one and the currency is bullish with the long-term fundamentals then this is a decent reason to trade into a risk event. If the event is expected to be negative or worse than the previous one and the currency is bullish in the long run then there is no real reason to trade into the event and should be left alone under most circumstances.
Once you have the expectation and you know the big picture fundamentals your next step is to try and find as many analyst reports as possible. Analysts are experts at putting all of the information together, creating different scenarios, and trying to figure out the likelihood of something happening or not. They will write interesting articles on what to expect from the upcoming risk event and why they feel a particular outcome is likely. This gives you a final round-up of how the market is viewing the event overall.
Once we have a risk event that we are confident to trade the next step is actually entering the market. As with day trading the news feed the important thing is not so much where you get in but rather that you are in at some point before the day of the risk event itself. If you are correct in your analysis the markets will start moving in the expected direction in the run-up to the event and you can actually book your profits before the event is even released.
As a general rule, the closer to the release you enter the market the fewer pips you should look to make. The goal of trading into risk events is that you should take your profits before the event is actually released so that you save yourself any of the risk associated with holding through a volatile news release.
Of course, if you want to hold on to your trade for extra pips that is fine too. However, if you are only getting in on the morning of the release then you may consider holding through the event because you will not likely have many pips on the table. If you do that then you should always have a day trading size stop in place and if the price is closer to your target than it is to your entry you should make sure that you do not lose pips on that trade. If the risk event comes out as expected then you will likely get a reaction in your trade direction but if it comes out opposite as to what you and the markets were expecting then the price will quickly reverse the entire move that led up to the risk event.
The quickest way to get good at trading risk events is, of course, to practice trading them in real time.
Let’s do a recap on how to trade into a risk event.
- First, you need the forecasts and expectations for something that matches the overall fundamental view for that currency either positive or negative.
- Next you research and check what other analysts are saying to give you extra views and preparation.
- Finally, you need to get into the position as early as possible at the best possible price. Technicals could help with this but you could also use a position splitting technique if you are unsure about getting in at the market or waiting for a pullback. If the trade plays out you should look to exit sometime before the event so that you are not exposed to any more risk.
Trading out of a Risk Event
Sometimes there will be no clear expectations for a risk event that we can trade into despite the fact that the event is viewed as important and potentially a high-impact event. In this scenario, we keep a close eye on the event and try to trade out of it instead. This is generally viewed as safer because we know very quickly whether we were right or wrong with our expectations. If we didn’t have any expectations then waiting for the risk event to be released will tell us how to trade it based on the deviation in the number from the expectation.
How can we trade out of a risk event event?
The process of trading out of a risk event is very simple. First, we highlight the events that could potentially impact the markets then we do the same kind of research and determine how anticipated the event is by the markets and analysts. Next, we identify what is a possible deviation from the expected figure that could potentially impact the price significantly.
For example, if an unemployment figure is expected to show a reading of 5.8% then a reading over 6.0% would be considered much worse and potentially worth trading short. Conversely, if a reading of 5.5% came out this would be considered good and worth trading in the long direction.
This does not mean that you want to be trading every risk event whenever there is a deviation. Rather, it’s best to line up deviations with the overall fundamental picture. For example, we want to be waiting for an event just in case there is a positive deviation because this lines up with the overall positive fundamentals that is driving the currency right now. The opposite is true for currencies with a negative view on them; we would be looking for negative deviations on high-impact events.
While you are learning it will pay dividends to really make sure that you are getting as much analysis from the premium news feeds as you can because they will walk through the plan of each risk event each day. The news feed will contain detailed plans and research for every major event that you can use to help with your trading. This makes it very important to get a trial of some of the various news feeds and consider factoring in the cost of this to your business plan.
The general rule for trading out of risk events is taking advantage of unexpected deviations from what the market is expecting. Of course, you cannot plan these because they are unexpected but it is certainly worth being at your desk when the releases come out so that you are ready to take advantage when this type of event does occur.
Now that we have a collection of short-term strategies the next thing to do is to start zooming out a little bit and look at ways to trade the markets without being tied to your desk if that is the path that you wish to go. It’s worth having a good understanding of how to trade in this way for when you potentially manage much larger funds that requires more careful trade management.
How to Trade Upcoming Risk Events
After you have your assessment of the fundamentals look for an economic event that is expected to be better than the previous number to be released. If the fundamentals are not looking so great then you would be looking for the economic event to come out worse than the previous.
As long as the number is expected to come out in line with the fundamentals traders can place a trade before the figure comes out in line with the fundamental outlook. If we are looking at a positive fundamental situation and the economic number comes out in line or better than expected the pair will likely rally in the direction of the fundamentals. However, if the number misses expectations we will probably see a decline against the big picture.
The point is that the big players in the market are placing their trades in accordance with the long-term fundamental outlook. One figure that is counter to this outlook will not change anything in a series of many figures in line with the fundamentals. All this deviation will do is simply provide a better place for the professional traders to get back into the market at a better price. In this case, we should expect the market to continue back in line with the fundamentals shortly after the figure is released if the figure was not in line with the fundamentals.
In essence, you potentially profit by getting in before the event even if the event does not come out as expected. In this case, you will have to sit through some drawdown but the idea is that if the fundamentals remain intact then this drawdown will be temporary and price will eventually come back. This also gives you an opportunity to add to the trade when it has pulled back against you. However, you should not already have a full risk amount on the position if you are planning on adding to your position if the price goes against you. Your trading plan should detail this.
The goal is to get in at the best possible price so adding intelligently to a position at a better price isn’t a bad idea. Of course, solid money management should be used and this type of trade should only be employed by traders that have plenty of experience in the markets.
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