Headline risks are some of the key features of the financial market. Experienced traders know that these risks are always available in the market.
In the past few years, we have had some key notable headline risks. Some of them were the Brexit vote and the Donald Trump election in 2016. We also had the headline risk of the Covid-19 pandemic and the Russian invasion of Ukraine.
In this article, we will explain how to trade when there are these headline risks in the financial market and how to make sound decisions.
»Related: How to do news trading
Types of headline risks
Broadly, there are two types of headline risks in the market. One that traders are familiar with and can predict, thanks to the cyclicality of the markets, while another totally unexpected that requires greater responsiveness in reacting to the trend of the charts.
First, there are the expected risks that happen in the market. A good example of expected risks are those in the economic calendar and those that traders know will happen.
For example, an interest rate decision by the Federal Reserve is an expected risk because investors are usually aware that they will happen. The same is true with companies' quarterly results and elections.
Second, there are the unexpected risks in the market. These are things that happen without a warning. There are numerous examples about this. For example, there is a period when a company announces the sudden death of its senior executive or when there is a merger and acquisition deal.
Another example of an unexpected risk in the market is when the SEC or another regulator announces a major investigation of a company.
Fear and greed when trading headline risks
A key thing that happens in the market is known as fear and greed. The idea is that traders tend to be highly reactionary and are usually guided by fear and greed. For example, in case of a bad news, they will tend to overreact at first.
When the World Health Organization (WHO) announced the Covid-19 pandemic, most stocks declined by more than 10% within a short period. At the time, most traders were starting to predict the next global depression.
And in 2022, most stocks declined sharply when Vladimir Putin of Russia decided to invade Ukraine. Most shares dropped as the market weighed the western response to the situation.
Greed is another key concept that happens when there is a major headline. For example, when a company publishes strong earnings and guidance, the stock tends to climb.
Strategies to trade headline risks
There are several strategies to use when there are headline risks in the market. Let us look at some of them.
Buying the dip or selling the rip
The first common strategy when it comes to trading headline risks is to either buying the dip or selling the rip.
The concept behind this is simple. You can buy an asset whose price has dropped sharply and hope that its price will rebound in the coming sessions. In most cases, this strategy works because stocks tend to rebalance as the market digests the new information.
Another approach is known as selling the rip. This is a situation where traders assess the risks and decide that the stock will keep falling after the headline risk emerges. A good example of this is Meituan, a large food delivery company in China.
The shares dropped sharply after China announced that food delivery companies needed to pay their riders as workers. Since this was a major issue that changed the company’s strategy, the stock kept falling.
Staying in the sidelines
Another concept that traders use when trading headline risks is to stay on the sidelines. This happens mostly in the case of unforeseeable risks.
In this case, a trader will stay on the sidelines and wait for the market to stabilize. This happens because traders will often miss the initial movement that happens when the event happens.
Another simple strategy for trading headline risks is known as bracket orders. This strategy is mostly useful when you expect events to happen in the future such as earnings.
For example, assume that a stock is trading at $50 heading to earnings. And in most cases, we know that a stock tends to move sharply upwards or downwards after earnings. Therefore, in this case, you could place two trades that takes advantage of these movements.
First, you could place a buy-stop at about $52 and then protect it with a take-profit at $54 and a stop-loss at $50. In this case, if the company publishes strong results, it will open sharply higher and test the $52 and take-profit at $54.
Second, you could place a sell-stop at $48 and a take-profit at $45. In this case, if the stock underperforms, these trades will be initiated. In other words, you have taken a neutral stance and will make money regardless of what happens.
Avoid overnight trades
Another approach to trade when there are major headlines is to ensure that you are out of the market in the overnight session. The idea behind this is simple. Risks don’t disappear when the market is closed and some key events could have implications in the market (and create morning gaps).
If these events happen, then we could see some major market action. Therefore, you can solve this issue by ensuring that you have closed all your trades before the market closes.
For traders, headline risks are always present. Some, as we have said, are in the nature of the market and can also be predicted, such as those related to earnings or FED decisions. Others, however, are completely unexpected and can damage your trading account.
We have seen that there are some strategies to be able to generate profits anyway, but staying out of the market or waiting for it to stabilize a bit are also valid strategies. It all depends on your trading style and attitude to risk.
How do you deal with headline risks?
External useful resources
- Headline Risk: How To Avoid Letting The News Mess Up Your Investing - Forbes