Event driven traders who apply simplistic logic of “news good - buy, news bad -sell” often suffer losses as a result. In trading, as in real life consequences never tend to be so black and white. Just as we must always practice nuance in our day to day affairs, so too in trading successful analysis requires a great deal of flexibility in order to consistently achieve profit.

The question that we must ask each time we trade an economic release isn’t whether the result has beaten expectations, but whether the news is tradable or fadable. In other words, is this piece of information likely to generate continuity in price or a correction? As simple as this question may seem, I believe it lies at the heart of the reason why trading is such a challenging activity, because it implies that every moment in the market is unique and profits therefore will elude all those who try to apply a universal approach to each trade.

Many of my friends who trade strictly on technicals love nothing more than to gleefully point out to me how positive news often leads to sell offs and negative news leads to rallies. News, they conclude. is therefore worthless and most technicians wind up fading the knee jerk spikes that accompany the release of data. Quite often they are right. Price retraces and they are able to bank some quick and easy profits. However, pity them when they are wrong and price barrels though their position like a Mack truck on a midnight run, and all they can do is scramble for cover as losses mount by the second.

My view is that technical trading in and off itself is extremely limiting and ineffectual in the long run. Someone once said that trading strictly by technicals is like driving a car by only looking at the rear view mirror and that’s an apt analogy. When we drive we always gather information from both the back and the front - why should we trade differently? The future isn’t set by the candles on the chart, its dictated by the events that hit our news screen. However, those candles DO often determine the impact of the news.

Bad news after a prolonged sell off, generally has little follow through and can frequently result in a surprising rally, as profit taking and short covering kicks in. Good news can also fail to produce any additional upside, if it comes on the heels of an already powerful up move. So we go back to the question of what’s tradabale and what’s fadable.

Here is a checklist I go through before putting on an event driven trade. It is by no means the definitive work on the subject, but it may help you create a model of your own.

1. How important is this piece of data?

First and foremost understand what matters to the market and what does not. US Industrial Production is far less interesting than Non-Farm payrolls. GFK German consumer confidence is much less market moving than the IFO report. When trading event risk you should focus only on the data that has lasting impact and that generally comes to down to about 6 pieces of info for each G10 currency.

Employment
ISM and PMI readings
Retail Sales
Inflation gauges (PPI, CPI)
Key sentiment surveys(IFO, Tankan, U of M)
And last but certainly not least, Central Bank announcements, release of Central Bank minutes and general monetary officials chatter.

2. How Big is the Surprise?
The key to market action is dislocation. Price movement occurs when equilibrium is disturbed. Therefore the greater the surprise the greater the disturbance, the more possibility for further price action.

3. What has Price Done up to that Point?
Has price rallied into the good news? Sold off into the bad news? The key question you want to answer is how much of the news has been anticipated? The bigger the pre-news move, the greater the need for a massive surprise in order for price to continue its present path.

4. What’s the BIG story of the day?
This is perhaps the hardest and most difficult question to answer. Sometimes you can have all the elements line up on an event driven trade and still lose money if some other piece of news dominates market trade that day. For example a positive economic surprise out of Eurozone may have no impact on the euro on the day that Moody’s announces that all of Eastern Europe is going bankrupt and European banks are left holding the bag. In a battle between micro and macro, macro will win every time. That’s why reading the days newsflows is key. You should scan the headlines in Bloomberg, FT, Dow Jones, UK Guardian, Telegraph, London Times every day and watch CNBC Asia, Europe or US to just get the feel of the dominant story of the day.

The best trades tend to be positive economic surprises after a massive sell off or vice versa - negative shocks after rallies. The more dislocation the greater the chance of price continuation. But like all good trades the best setups are rare. Therefore, on day to day basis I struggle with the data presented and try to draw the best analytic conclusion.

Three final rules I apply before I enter a trade.

1. Does the 5 minute candle confirm my thesis?
If I am bullish the pair after the news - is the candle green? I won’t take the trade until it is. The same goes for my shorts.

2. Trade the cross - not the major.
If the news is UK/EZ/AUD positive or negative I will generally always try to express the trade through a cross in order to minimize the dollar impact. I don’t want the dollar flow to pollute my position. For example news may be euro positive, but if risk aversion reigns supreme in the market the euro may still lose ground against the buck, but could gain against the pound. Trading the cross often allows you to make a purer bet on event driven trade.

3. Trade two units.
I tend to set up my first target at 2/3rds risk ( if I am risking -30 points my T1 will be +20) and will trail the rest by two bar low/high(depending on if I am long or short) You never know how far a trade can take you. That’s why letting the second unit run is the only way I can try to generate excess profit and capture alpha.

So that’s in a nutshell is how I determine what’s tradable or fadable in the currency market. The reality of course requires practice and relentless amount of homework. The utimate rule that I live by is - understand the story, then undertake the trade.

Boris Schlossberg serves as director of currency research at GFT, and runs bktraderfx.com.