Relevant news releases act as salient catalysts for the foreign exchange (also known as forex and FX) market as many event-driven players use them to take positions. No less than seven pieces of relevant data come out on a daily basis from the countries of the eight most commonly traded major currencies.
Unlike the equities or bond markets, the FX market, open 24 hours a day (from 5 pm ET Sunday to 4 pm ET Friday), are trading at the time of most of these news releases.
Numerous empirical studies have helped researchers gain insight into the reaction of the FX market – the price movements and the trading volume – to news releases.
The impact of news on FX price movements
News is the main driver of short-term shifts in the global FX market. Dozens of fundamental announcement come out each weekday in all time zones from many countries. Most traders, however, need not pay attention to all of them and must differentiate the important ones from the less impactful ones. Since the U.S. dollar (or USD) accounts for 90% of all currency trades, U.S. economic announcements tend to inject the most pronounced effects into the market. Releases of news directly pertinent to the other major globally-traded currencies – the Euro, British pound, Japanese yen, Swiss franc, Canadian dollar, Australian dollar and New Zealand dollar – may also deserve the attention of traders trading those currencies.
Expected announcements from global central banks about interest rates and monetary policies are some of the most watched news items and can create extremely large, quick changes in FX rates. Backward-looking economic data releases such as unemployment rates and industrial production vary in their impacts at different times. For instance, unemployment data is extremely pertinent in times of economic recession.
Analysts produce estimates for these various economic releases. An aggregation of these different estimates, such as the median or the mean, produces a “market view” of the data release. During aggregation, analysts with greater historical success of accuracy may be given a greater weighting. The most well-known analysts may be heeded much more than their peers; sometimes, prominent analysts’ revisions are substantial enough to move FX markets. Shortly before the release of economic reports, the market prices in its expectations for them, which is usually close to the aggregation of analyst expectations.
This process of pricing the expectations into the FX market is called consolidation. From a technical analysis perspective, consolidation is characterized by a narrowing trading range. Consolidation is a critical requirement for a high reward-to-risk trade because it provides evidence that the market has reached equilibrium in its expectations of the economic news release. Furthermore, consolidation shows that there are no other ongoing news stories that are driving the market. Contrastingly, if a currency has a strong bullish or bearish trend, it is possible that the market will largely ignore the impact of the announced number and continue in the prevailing trend.
After consolidation, if the presented economic number greatly differs from the market’s expectations, FX rates may break out of a trading range. Typically, actions of algorithmic and flash event-driven traders will produce a large move of 10-50 pips that occurs in less than 10 seconds. If the news is significant enough to affect investors’ view of particular economies, this move will be followed by a gradual move of another 50 pips that can last for minutes to hours. Some empirical studies[1] show that the market reacts more sharply to bad news than to good news[2].
In general, the highest frequency of FX trading happens within 10 seconds after news releases. A study by Martin D.D. Evans and Richard K. Lyons, however, show that sometimes, the market could absorb or react to macroeconomic announcements hours, or even days, after they come out based on multiple factors. The study also found that the impact on returns generally occurs in the first couple of days and then tapers off. The impact on order flow, on the other hand, still keeps very strong and often noticeable on the third and fourth day (Kathy Lien, March 16 2011, How to Trade Forex on News Releases).
Others studies, however, from French and Roll (1986) and Fleming and Remolona (1999), for example, argue publicly available news may be incorporated in prices instantaneously; this view discourages traders from taking positions based on news released hours or days earlier.
Large institutions, which dominate the global FX market, use news events as signals to move their treasury holdings from one currency to another. These large currency trades are executed incrementally – in order to minimize slippage and market impact and to prevent detection by other market participants – using methods such as Volume Weighted Average Price (VWAP) algorithms, which attempt to track the volume-weighted price during a specified time period to break up the large orders into smaller blocks.
The VWAP algorithms’ tracking of the market tends to push the market price along a linear trend line towards a target. Strong linear trend lines can be quantitatively characterized by high Sharpe ratios (risk-adjusted returns), an indication of the high signal-to-noise ratio present during particular news events. These movements may present favorable reward-to-risk opportunities to traders who can identify them.
When traders learn of new developments, they usually estimate new target rates and trade towards them, attempting to capture the spread between the target rate and the current rate. The gap between the two rates may be closed by market dislocations created by two factors. The first is information leakage, which is information disseminating to different market participant at different times. Well-connected and vigilant traders, for example, may obtain certain information earlier than most other FX market participants. The second factor is the aforementioned gradual VWAPs of the larger institutions.
The impact of news on FX trading volume
Global FX trading activity tends to increase after news releases, even when announcements are in tandem with market expectations. Additional trading activities may be unleashed if announcements deviate from expectations. However, the FX market may also be in a “wait and see” mode after shocking announcements, sometimes for hours or even days, as traders may be reluctant to make large moves during periods of heightened uncertainty. It will inform traders more of market behaviors based on complicated psychological states that may deterministically influence the trading volume towards news releases.
Studies on FX volume is difficult, however, since the market covers the entire globe, spans various products and microstructure aspects such as multiple trading platforms and different trading venues like brokerage or interdealer market.
Many studies on FX volume have resorted to using settlement information from the Continuous Linked Settlement (CLS) Bank in New York because the CLS data[3] is aggregated at high frequencies and ensures a representative coverage (roughly 55%) of global trading volume in the FX market. CLS currency volumes are denominated in the USD because cross currency activity outside it is limited and USD has the strongest volume response to news releases.
Based on this data, FX trading volume rises about 5% on average in the spot market the day of and the day after relevant macroeconomic news releases. Studies[4] based on regression models also show that FX volume augments on the day of news releases, keeps the upward movement three or even four days after that and then tapers off. During the 10-day period after the announcement, FX trading activity goes down by a cumulative 20% on average from peak volume.
The international FX market is vulnerable to short term shifts ignited by economic announcements. For traders who want to profit from Forex trading, the importance of “following the news” should not be understated; prominent releases pertinent to the prevailing economic reality deserve additional attention. As the FX market is impacted in periods before and after news releases, traders should be aware their lasting effects on returns and order flow. For example, trading volume increases the most 10 seconds after news releases, remains elevated three to five days after that and gradually fades within 10 days. For traders, incorporating knowledge of news releases and their impact on the FX market with technical analysis could prove a successful and profitable combination.
[1]
Torben G. Andersen, Tim Bollerslev, Francis S.Diebold, April 2002,
“Micro Effects of Macro Announcements: Real-time Price Discovery in
Foreign Exchange”
[2] One of the examples of sign effects, which refer to the fact that market reacts to news in an asymmetric fashion.
[3]
The main advantage of CLS volume data is that decentralized FX trades
are centrally settled in New York. The data’s breadth captures volume
activity in the spot, swap, and forward market. Average daily values for
Dec 2007 were USD 611 billion for the spot market, USD 710 billion for
the FX swap market, and USD 139 billion for the forward market. After
Dec 2007, CLS also covers options exercises, non-deliverable forwards,
and credit derivatives. Since its introduction in Sep 2002, CLS Bank
captures more than half of the FX volume across major currencies at high
frequencies.
[4] Andreas M. Fischer, Angelo Ranaldo, March 19th, 2011, “Does FOMC news increase global FX trading?”
[4] Andreas M. Fischer, Angelo Ranaldo, March 19th, 2011, “Does FOMC news increase global FX trading?”
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