Know who’s trading and why

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NFP days can be great to illustrate how markets move because they really have the potential to motivate traders to act.

Not only is there the potential for a lot of movement, but there’s usually a good mix of different types of participant active in the markets – and it can be really important to know who’s trading and why on these sort of days.

Who’s active?

Okay so the backdrop to all of this is that central bank policies are the main driver right now for the markets as a whole. The QE programs that many central banks have implemented since the financial crisis have become somewhat of an obsession and even an addiction for the markets. The Federal Reserve’s QE was no exception. As economies become more stable however, the issue is that QE and low interest rates can lead to high levels of inflation if left unchecked.

So fundamental news such as NFP’s, inflation data, central bank meetings/minutes and whatever else they say they are currently looking at, tends to bring about a surge in activity due to the heightened level of importance it currently has.

With the Fed basically saying that they will raise rates at some point fairly soon, the NFP release which is pretty important anyway, gives the markets an opportunity to figure out the likely impact of jobs growth (amongst other important jobs data that’s released at the same time). Scalpers, swing traders, banks, funds and everyone else are all therefore likely to be active.

The stock-bond ‘relationship’

I find that day traders frequently struggle to grasp the relationship between different markets and unfortunately, because these relationships sometimes seem so clear, they start to lean on them as a tool to help in making context-based trading decision, only to find that they don’t hold.

For example, it appears to me that day traders commonly believe that the relationship between stocks and bonds is an inverse one. When stocks go up, bonds go down. And this is something that can happen. But the relationship is usually not directly between the stock index and the bond themselves – whatever the relationship appears to be is a consequence of what is driving the overall market. In this case the driver is the Fed interest rate policy.

In essence when interest rates go up, bond prices discount this and as low rates are meant to be supportive to an economy, stock markets go down. So given that both stocks and bonds could sell off in anticipation of higher interest rates, can you tell the difference between the 2 charts below of a stock index and a bond?

K K
Okay so maybe the prices in these charts will give you a clue to which one’s which, but they are very similar especially over the final day where NFP’s were released. Trying to trade one against the other with expectations of an inverse relationship would’ve proved costly.

Have a plan

Understanding the potential drivers is however, just the first stage if you are going to be trading on a day like last Friday. The next stage is to have a plan for what you think will happen and therefore what you might do, given the various possibilities of how the data might come out relative to expectations. This doesn’t have to be a well-documented plan, it’s just good to have an idea of what could happen, before the event itself.

For the NFP release, the expectation was ~ +235k and the previous figure was +257k. If it came out in line with or close to analyst expectations, then expectations of what the Fed might do with rates would be the same. A much lower number (at least below +185k) and the Fed might think twice about raising rates in the near term. Much higher (at least above +285k) and the Fed might have to consider accelerating the process of moving towards raising rates.

It came out at strong +295k with the previous revised lower by 18k – an overall +42k. Liquidity, short-term news players and probably the various other numbers released played a hand in an initial pop higher, but then the last scenario played out with the stocks and bonds moving lower for much of the session.

Know who’s trading and why

The final stage is of course, to see how the market actually reacts to the release as you never know what will happen. But if you know who’s trading and why or at least have a good idea, you’re going to have a much better idea of what could happen when big numbers are significantly different to expectations and the likely extent of subsequent moves. Recognizing this behavior when you see it will help you switch gears and make sure you’re on the right side of the move.

Trade well.

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Coach James

James began his trading career nearly a decade ago, learning his craft in fixed income derivatives. These days, he predominantly day trades index futures using auction context as the vital ingredient to his approach. James is a firm believer in the importance of trader psychology and how it can make such a monumental difference to how well a trader performs.

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