Importance of News
It’s not enough to only know technical analysis when you trade. It’s just as important to know what makes the market move.
Just like in the great Star Wars world, behind the trend lines, double tops, and head and shoulder patterns, there is a fundamental force behind these movements. This force is called the news!
To understand the importance of the news, imagine this scenario (purely fictional of course!)
Let’s say, on your nightly news, there is a report that the biggest software company that you have stock with just filed bankruptcy.
What’s the first thing you would do? How would your perception of this company change? How do you think other people’s perceptions of this company would change?
The obvious reaction would be that you would immediately sell off your shares. In fact, this is probably what just about everyone else who had any stake in that company would do.
The fact is that news affects the way we perceive and act on our trading decisions. It’s no different when it comes to trading currencies.
There is, however, a distinct difference with how news is handled in the stock market and the forex market.
Let’s go back to our example above and imagine that you heard that same report of the big software company filing bankruptcy, but let’s say you heard the report a day before it was actually announced in the news.
Naturally you would sell off all your shares, and as a result of you hearing the news a day earlier, you would make (save) more money than everyone else who heard it on their nightly news.
Sounds good for you right? Unfortunately this little trick is called INSIDER TRADING, and it would have you thrown in jail.
Martha Stewart did it and now she has a nice mug-shot to go along with her magazine covers.
In the stock market, when you hear news before everyone else it is illegal. In the forex market, it’s called FAIR GAME!
The earlier you hear or see the news, the better it is for your trading, and there is absolutely no penalty for it!
Add on some technology and the power of instant communication, and what you have is the latest and greatest (or not so greatest) news at the tip of your fingers.
This is great… Uhmmm… “news” for retail traders because it allows U.S. to react fairly quickly to the market’s speculations.
Big traders, small traders, husky traders, or skinny traders all have to depend on the same news to make the market move because if there wasn’t any news, the market would hardly move at all!
The news is important to the Forex market because it’s the news that makes it move. Regardless of the technical, news is the fuel that keeps the market going!
Summary: Market Sentiment
Did those thousand-pip moves excite you?
Before we start betting the farm based on our analysis of the COT report, remember that those were just specific cases of when the COT report signalled a perfect market reversal.
The best thing to do would be to back test and look at reasons why a reversal took place.
Was the economy booming?
Or was it in the middle of a recession?
Remember, the COT report measures the sentiment of traders during a specific period of time. Like every other tool in your toolbox, using the COT report as an indicator does not always correlate to market reversals. So take the time to study this report and get your own feel of what works and what doesn’t.
Also, before we bring this lesson to an end, always keep in mind that market prices aren’t driven by solely COT reports, stochastic, Fibonacci levels, etc.
The markets are driven by the millions of people reacting to economic analysis, fundamental reports, politics, Godzilla attacks, UFO sightings, Lady Gaga concerts – life in general! It is how you use these tools that will help you be prepared to what lies ahead.
In conclusion…
As traders, it is our job to gauge what the market is feeling. One way to gauge market sentiment extremes is through the Commitment of Traders Report. By understanding the activities of the three groups of traders (commercial traders, non-commercial, retail traders), we can find ourselves in better positions to fish for tops and bottoms. Remember, every market top or bottom is accompanied by a sentiment extreme, but not every sentiment extreme results in a market top or bottom.
Getting Down and Dirty with the Numbers
Now that we know how to determine sentiment extremes, what’s next? Recall that not every sentiment extreme results in a market top or bottom so we’ll need a more accurate indicator. Calculating the percentage of speculative positions that are long or short would be a better gauge to see whether the market is topping or bottoming out.
The equation to calculate for the %-long and %-short is indicated below:
To illustrate this better, let’s go back a few years and see what happened with Canadian dollar futures.
Going through the COT reports released on the week ending August 22, 2008, speculators were net short 28,085 contracts. On March 20, 2009, they were net short 23,950 contracts. From this information alone, you would say that there is a higher probability of a market bottom in August since there were more speculators that were short in that period.
But hold on a minute there… You didn't think it would be THAT easy right?
A closer look would show that 66,726 contracts were short while 38,641 contracts were long. Out of all the speculative positions in August (66,726 / (38,641 + 66,726)), 63.3% were short positions.
On the other hand, there were just 8,715 long contracts and 32,665 short contracts in March. This means that (32,655 / (8,715 + 32,665)) 78.9% of the speculative positions were short positions during that period.
What does this mean? There is a higher chance that a bottom will occur when 78.9% of all speculative positions are short as opposed to just 63.3%.
As you can see on the chart below, the bottom in fact did not occur around August 2008, when the Canadian dollar was worth roughly around 94 U.S. cents. The Canadian dollar continued to fall over the next few months. By the time March came around and the %-short ratio hit 78.9%, the Canadian dollar had hit a bottom around 77 U.S. cents. Then what happened? It started to steadily rise! A market bottom? Yep, you got it.
