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How news affects market volatility

To understand how news can affect the volatility of prices, you need to consider how other traders prepare for and react to its release.

Before the release

In the case of news that is pre-scheduled, some traders stop trading just before an announcement and close any positions that they have.

Others decide to keep positions, or open new ones, but use tighter stop losses.

As there are many traders and institutions closing and opening positions just before the news release happens, you find that there is an increase in price volatility, as buy and sell orders become processed.

There is often an increase in price volatility just before an important news event as traders close positions, move stop losses or open new positions.

 

After the release

As soon as the news is released, there is another surge of activity.

Traders pursuing news trading strategies now enter the market, increasing the volatility.

Meanwhile, other traders get stopped out and automatically exited from the market – remember that stop loss orders are orders to buy and sell – and so this increases the price volatility further.

Volatility often increases immediately following the announcement as traders respond with new trades and stop losses become hit.

 

Automated trading increasing the activity further

You should also bear in mind that a lot of trading is now automated and is most often used to employ "high-frequency trading" – lots of small trades that flood the market with activity causing volatility.

Observing the increase in activity on a chart

You can observe the increase in activity directly on a chart.

This following chart shows you one scenario, where there is increase in activity in price action for the EUR/USD currency pair, on a 1 minute chart, on March 14, 2013:

The vertical line displays the moment when the news was released.

  1. Blue area showing low price activity shortly before the news event.
  2. Orange area highlighting low volatility on the ATR, prior to the news event.
  3. Green area highlighting the increase in price action during the release of the news event.
  4. Red area highlighting the increase in volatility on the ATR during the news event.

Increase in price action on the chart explained

In the chart above, important economic data was due to be released at 12:30 on this day – the exact moment of the release is shown by the black vertical line.

The area highlighted in blue, at 1, marks the time from 12:20:00 to 12:29:59. As you can see, only very short candlesticks formed during that time – price volatility was relatively low.

The Average True Range (ATR) indicator, which measures price volatility, is shown underneath the chart.

Up until 12:29, the ATR indicator also showed that volatility was low. However, at 12:30 – the exact time that the news was published – the price volatility, shown in the green area at 3, showed a significant increase and the ATR indicator reading suddenly increased sharply, shown in the red area as 4. This volatility increase continued until 12:41, before dropping down again.

This shows you the typical price action around an important news release.

Volatility is usually determined by the importance of the news

Ultimately, how much volatility and when it increases depends on how much importance traders attach to it.

Generally, if traders consider a piece of news important, then volatility is generally expected to increase significantly.

If traders consider a news particularly important, then you will usually see much more of an increase in volatility, than one that is not considered that important.

 

How long the effects of news last

Some news events only affect volatility and prices in the short term. Others may trigger the beginning of a new long-term trend.

Before you place a trade, decide how long you think a news event will affect the market you are trading. This will dictate what time frames and charts you use.

To trade the initial momentum immediately following a news release, a tick chart and the M1 time frame are usually the most suitable.

If you wish to wait and see how the price was affected first, it is often better to use a 5-minute chart or – if you believe the news is highly significant – a 15-minute chart.

If a news event has a longer-term impact on a market – for example triggering the start or strengthening of a trend – you may decide to use 1 hour charts after the news has been released.

Before you trade on the back of a news announcement, decide how long you think it will impact prices – this will determine what time frames and charts you use.

 

Summary

So far you have learned that...

  • ... there is generally a surge of activity just before and after a news release that increases the volatility of the price.
  • ... you can observe this increase in activity on a price chart.
  • ... sometimes, volatility will increase just before and sometimes just after.
  • ... you can observe the increase in price action directly on a chart.
  • ... the volatility is usually affected by the importance that traders place on the news being released. If there is a high importance then there is generally more activity.
  • ... different news events will have a longer – or short-term impact on prices – this will determine what time frame you use for trading.