[dc]R[/dc]ichard asks: “I saw a trade setup, but also saw reasons not to take it. [MACD divergence] A news release was also scheduled soon, and a large move before the report set up the trade again. I didn’t take the trade, but the report caused a large shock in the direction of the trade I would have been in. Question: Did the strong bar restore the edge that was weakened by the MACD divergence or was it just selling on rumour? Coulda had a nice instant profit!”
Good question, Richard, and I think there are a few things here to think about. First, I’m not a huge fan of MACD divergence or any kind of divergence. Conceptually, it is valid—weakening swings do not tend to set up the best continuation trades (a corollary to: the best continuation trades are set up by good impulse and momentum). The problem comes when you try to measure this with an indicator, because you’ve now brought in all kinds of artifacts from the indicator. The indicator is more responsive over certain cycle periods, and how do you test all of this? (It can be done; it’s just very difficult.) You can’t trust your eye with these things unless you’ve objectively looked at thousands of trades, and I find that momentum divergence is generally a sub-par trading tool, so I don’t use it. Note that I might, however, cue into the same thing through other tools or other analysis—I think I incorporate a version of this into a more holistic view of the market.
Now, your question really deals with trading before news. Academic theories tell us that markets very quickly incorporate news into the price of the market, and that the arrival of that news (= new information) is essentially unpredictable and random. This is the theory, but there are some important ways in which it fails to perfectly describe reality. There is good evidence that information often leaks before reports, and I’ll share some of that in a future blog post. (Why is this important? Because if information leaks before reports it has an impact on the price. If you can read that impact then it is theoretically possible you could get an edge on the price direction after the report.) Timing of many news releases is also well known in advance, and there are other things that make many news releases a bit less-than-random. However, the basic idea is valid: news can have a large and mostly unpredictable impact on prices.
For traders, the biggest thing to realize might be that volatility can change in a split second: a stock that normally has a $0.50 average daily range can trade in a $20.00 range in single second following an unexpected news release. This volatility can continue, or it can die as quickly as it came. There are traders who specialize trading around reports, and it is possible to do so, but make sure you have the skills and can manage the (very difficult to quantify) risk. For a developing trader, it probably makes sense to stand aside before a news release. (Stops can really be whacked with extreme slippage, so putting a stop in is not necessarily the answer to all your woes.) As a technical trader, all you are doing is identifying when a market might have a statistical tilt to do something as opposed to something else. You then put on a position, and manage the trade—and then you repeat that simple process over and over. News and economic reports can complicate this picture, so either choose to specialize or try to minimize the impact they have on your trading results as much as you can.