DailyFX Tips & Picks: How to manage risk when trading around news events

WITH the ECB meeting this Thursday, and the US non-farm payrolls report out on Friday, the FX markets are bound to experience a great deal of exuberance. With volatility, we stand to make a great deal of money – but also to lose a great deal if risk is not managed properly.

When does calculated risk-taking turn into forex roulette? With news events come strong moves and price spikes. Common sense says that anyone trading short term, expecting gains of 10 to 50 pips, would close out positions just ahead of the news release. The reason is that most common spike lengths would be within this range. The actual event outcome might even support your view, and price may ultimately trade in your direction. But this will not stop price from trading against you by 50 pips before turning in your favour. The reason is that big institutions trade with very little volume around news events, as they also want to avoid the risk of random short-term moves.

Longer-term traders would, however, keep their positions open, as long as the outcome of the event goes in line with their longer-term view and no major levels are taken out. Longer-term traders expect larger gains, so they trade with wider stop loss orders, allowing them to withstand short-term noise. They would also place stop loss orders and profit target orders based on levels seen in the daily or weekly time-frame. These levels are the most important, determining trends that will affect traders months ahead. A weekly or daily level may be tested on news, but it will seldom fall unless there is a genuine reason for a break of the trend.

Alejandro Zambrano is a currency analyst at DailyFX. Azambrano@dailyfx.com Twitter:@AlexFX00