EP143A How news events affect forex trading

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News events play a crucial role in forex trading, as they influence currency supply and demand. When major economic reports or geopolitical events occur, traders react by buying or selling currencies, leading to increased volatility. News can create sharp price movements, trend reversals, or breakouts in the forex market. Understanding how news affects trading helps traders anticipate market reactions and make informed decisions.

Economic data releases, such as interest rate decisions, inflation reports, and employment data, significantly impact currency values. For example, if the U.S. Federal Reserve raises interest rates, investors flock to the USD, causing EUR/USD to drop as the dollar strengthens. Conversely, if U.S. job data is weak, traders may sell the USD, making GBP/USD rise. Unexpected results often create extreme volatility, as traders adjust their positions in response to new information.

The Federal Reserve (Fed) increased interest rates in the United States in late 2022. The Fed raised the federal funds rate (FFR) four times in a row in the second half of 2022, and then increased it again in its final meeting of the year. [Source: https://www.google.com/finance/quote/USD-EUR?window=5Y]

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News events can trigger two types of reactions: gradual trends or immediate spikes. A gradual trend occurs when economic data consistently supports a strong or weak outlook, leading to a long-term price movement. For example, if the European Central Bank signals a long-term plan to raise interest rates, EUR/USD may gradually rise over weeks or months. On the other hand, an immediate spike happens when surprise data is released. For instance, if U.S. inflation is much higher than expected, the USD may spike instantly as traders rush to buy it, before stabilizing within minutes or hours.

The risk is that pricing may be too aggressive, leaving short euro positions exposed if the ECB signals a slower pace of cuts or an eventual pause. 

Source: Bloomberg: https://www.forex.com/en-uk/news-and-analysis/eur-usd-ecb-rate-guidance-clouded-as-central-banks-hit-pause/

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Geopolitical events and crises also impact forex markets. Elections, wars, trade disputes, and political instability create uncertainty, which often leads traders to safe-haven currencies like the USD, JPY, or CHF. For example, when the Russia-Ukraine war began in 2022, the USD and CHF strengthened as investors sought stability, while the Russian ruble collapsed due to economic sanctions. In contrast, a positive trade agreement between two countries can boost their currencies as investors gain confidence in their economies.

Peak in 2022 due to the Ukrainian war. Source: Google Finance

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Conclusion

Trading news events requires caution and strategy. High volatility can result in rapid gains but also sharp losses. Some traders use a news trading strategy, where they enter positions just before or after major announcements, while others avoid trading during news releases due to unpredictable price swings. Understanding economic calendars, market sentiment, and risk management is essential to navigating news-driven forex markets effectively.

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