Economic Releases: How to Trade the Head Fake

The monthly unemployment numbers were released Friday and they were terrible...the unemployment rate hit a 16 year high at 7.2%. What's interesting is that the dollar ended up rallying against the euro after the economic release. Fortunately, I was able to make several good trades in the pair, both long and short. In this post I will share one setup that I use for trading economic releases.

First, this setup does not work with all economic releases, only big releases that generally move the market...or at least build a lot of anticipation about being market moving. Second, there needs to be a fairly strong consensus as to what is expected (like expecting a high unemployment rate).

Friday morning I had my charts up and CNBC on about an hour before the unemployment rate was released and I noticed the Eur/Usd was trading in a pretty congested range in anticipation of the release. The talking heads were talking about the up coming economic release and they were all in agreement that it would be a bad release. Then Rick Santelli came on and said that the pit traders were saying that it was not only going to be bad, it was going to be even worse than expected. This is the type of consensus I like to see when trading economic releases.

Here's a 5 minute chart of the Eur/Usd pair leading up to the release:
Okay, so I see the narrowing range and I hear that the unemployment rate will be worse than expected, (which is humorous because it is actually expected if it's being broadcast on CNBC) now what? If the street is expecting a bad number, then the pros probably know that the amateurs will think that the dollar will surely fall if the unemployment number is so bad. This is were the "head fake" comes into play.

The head fake or knee jerk reaction to the economic release is generally a false move and it allows professional traders to take out the amateurs' stops and position themselves for the big move in the right direction. For my setup, I enter before the news while the currency is in a tight range and I take a position in the direction that the amateurs are most likely taking (Friday's dumb money direction was to buy the Eur/Usd). The tricky parts of the trade are properly setting a wide enough stop (but not too wide!) and bailing out of the trade while it's in your favor. Here's a 1 minute chart that shows my entry, my stop and my exit after the release.
Notice how big the candle is for the minute that the unemployment rate was released. My stop was almost hit with the initial dip but then the pair quickly rallied in the "dumb money" direction and most likely took out lots of stops. To exit I use the 1 minute chart and I exit immediately at the first sign that momentum is waning. For this trade, the signal came in the candle after the release...the pair stop rising and then fell below the close of the prior candle...and I jumped ship and starting looking for a good entry in the opposite direction.

For the next trade, I pull up my trend following system and wait for it to give me a signal on the 5 minute chart. For this trade the signal came within 15 minutes from the unemployment rate release. Here's the chart:
As you can see from the above chart, the Eur/Usd kept falling after the release which provided a good trend trade.

So that's how I play the economic releases and I suppose you could just wait until after the release and the head fake to enter a position but I like to swing trade the head fake and get a few extra pips from the setup.

To recap, here's what you want to look for:

• A highly anticipated economic release
• A strong consensus that the release will be good or bad
• A very tight trading range to enter into, it's also good to get the trade in early because the spreads are still lower.

After all of the above are in place then:

• Enter in the trade before the release in the direction that the news release should move the market (the "dumb money" direction) and place a fairly wide stop
  
• Then look for a quick pop, which will most likely be the head fake and get ready to bail out when you see a loss of momentum on a very short time frame chart (1 minute or less)
• Last but not least, look to enter a new trade in the opposite direction if there is a follow through on the reversal.

Obviously this type of strategy is not for everyone, but it has helped me quite a bit when trading around market moving economic releases. When I first started trading currencies several years ago, I closed out many losing positions wondering why the market didn't go in the direction that it should have...now I've gained a little knowledge and a lot of experience and I know not to just jump on in the direction of the initial break. Just knowing about the "head fake" alone can save you from losing money is some painful trades...especially when you start with a profit and then watch it quickly turn into a loss.

There you have it. Good luck if you do attempt this type of trading, it can be nerve racking and frustrating at times. You have to be alert and also be ready to quickly admit defeat if your trade gets stopped out. Otherwise, there's the possibility of getting emotional and trying to trade your way out of the initial loss and we all know what that can lead to.

TLT