If you’re like most traders, you specifically avoid “event volatility” like earnings reports and key economic data releases.
But you should know that the majority of volatility is attributable to these binary catalyst events. Not knowing how to trade around these significantly cuts into your opportunity set.
One of the cornerstones of volatility events is the macroeconomic data release.
We’re taking the release of key economic indicators like GDP or CPI here. These dramatically alter how investor’s view stocks in relation to other investments and a surprise number causes traders and portfolio managers to panic and readjust their portfolio to agree with the new economic reality.
As short-term traders our goal is to take advantage of the panicked order flow present in these situations and find favorable low-risk entry points.
What is a Macroeconomic Data Release?
These are pieces of economic data released periodically, often by the government, that give us insight into how the economy is doing.
There’s an economic data point for nearly everything, whether it’s shipping, oil inventories, consumer spending, surveys with business owners, etc.
Most of these data points are on a release schedule, spanning from quarterly, monthly, or weekly.
For example, take Existing Home Sales, released by the National Association of Realtors (NAR). It’s a count of how many pre-existing homes (not new builds) sold in the United States in that month. The NAR is in a position to do this because nearly all licensed real estate agents in the US are members of NAR, giving them access to this level of data.
Existing Home Sales is published on the third Wednesday each month, typically around 10:00am EST.
You’ll find that most economic data releases have predictable schedules just as Existing Home Sales does, this way traders know exactly when the number is coming out and can position themselves accordingly.
The Problem with Tracking Economic Data Releases
There are too many data releases and too few to merit your attention. Looking at an economic calendar on any financial website like Yahoo Finance, you can see that there’s dozens of data points released every day, most of which you’re unfamiliar with.
Most of these releases don’t move the needle. The market largely ignores them, or they become but a small part of a larger macroeconomic model.
They don’t create volatility and increased price action, which is our stated reason for monitoring these.
The Economic Data Releases That Do Matter
Without a veteran to hold your hand and direct your attention at the appropriate catalysts, it can be quite hard to figure this world of economic data out. I know firsthand, so don’t feel strange if you’re confused when you look at an economic calendar. I’m not even sure what half of those reports even mean.
That doesn’t matter, what does matter is that you figure out on the few areas to pay attention to and closely monitor price reactions to these report releases.
Here’s a short list of the data points that actually move the market:
- Consumer Price Index (CPI) – the primary measure of inflation in the US
- Gross Domestic Product (GDP) – total value of goods/services produced by the economy in a given period
- Nonfarm payroll – a measure of how many people have jobs
- Federal Reserve meetings and their rate decisions
- Unemployment claims – how many willing workers are out of jobs
- Retail sales – how much product are consumers buying
You can find the precise date and time of release of these by looking at an economic calendar.
How Economic Data Releases Differ from Other Catalysts
If you’re used to trading earnings, FDA announcements, and other stock-specific catalysts, economic data releases will be new for you.
The effect of an earnings report is relatively easy to predict. If it beats market expectations, the stock will go up and perhaps its brothers and sisters within the same industry will benefit from a sympathy effect.
Things are a bit less obvious when it comes to economic data releases.
This is why the “global macro” approach to trading often describes the market as an interrelated puzzle, in which you have to draw second and third order conclusions from market events and news.
For example, in 2021 and 2022 we’ve experienced a number of extremely high CPI prints. There isn’t a direct connection to make from that. Some sectors, like value industrials, might actually benefit from a relative point of view, while “long-duration” growth stocks with high multiples of earnings are harmed.
But we can’t think about it in such a simple way.
Inflation affects the entire economy, not just the stock market. We have to consider how these movements in the stock market as a reaction to inflation relate to the global bond, commodity, and currency markets.
Perhaps we’re getting ahead of ourselves here, but the point is that interpreting economic data allows you to be more creative with structuring trades.
You can express the same view in several ways, but oftentimes figuring out the best way to do so is difficult.
How to Trade Macroeconomic Data Releases
There are two primary methods of trading on these economic releases: taking a directional view (‘stocks will go down on a high inflation print’) or taking a volatility view (‘puts are too expensive given that this Fed meeting will probably be routine’).
Taking a Directional View
A directional view is probably harder to do with regularity. After all, today’s market price is the composite of all traders’ opinions on the outcome of the event, you have to be consistently better than the rest to make money.
It essentially involves predicting not only the outcome of the data release, but how the market reacts to that release. The second part is not at all trivial. The market can be quite schizophrenic.
Besides the tall task of being right twice, this type of directional trading carries the additional burden of when you’re wrong, you’re really wrong. And because the outcomes of data releases are somewhat binary in nature, you don’t have time to trade out of your position, it essentially hits max pain instantly.
So, one way some traders approach this style of trading is to be a contrarian. They act as snipers, looking for the rare report where the entire market thinks one thing, but your conviction is in the opposite direction.
This way, if you’re right, you’re going to be right in a huge way as the market panics to reposition themselves. And if you’re wrong, well, the market expected you to be wrong, so it won’t be a massive loss. And sometimes being wrong might still make money as you might benefit from the “sell the news” effect.
Certainly, if I were a smooth-talking stockbroker, I would pitch you the contrarian option because it sounds better, but it’s probably equally as hard other than the fact that it’s more psychologically favorable.
There’s one last thing that you can do, which is simply take advantage of the volatility and momentum created by these catalysts after the fact. This way, there’s no forecasting required, you simply trade it as you would using your toolbox of trading setups.
Taking a Volatility View
The volatility view, on the other hand, involves taking advantage of what options trader’s call “flow effects.” When investors are forced to buy or sell options to hedge their positions, that can momentarily distort the price and make implied volatility too cheap or expensive.
The skill aspect here is making the judgment as to what constitutes an option being too expensive or cheap. There’s a number of methods that option traders use including fancy mathematical formulas that go over my head.
A practical approach for the non-mathematically inclined is to simply use history.
Look at the historical spread between relative and implied volatility in the lead up to past events and see how prices reacted. How much of a “vol crush” was there (when the implied volatility of an option plummets following a volatility event like an economic data release)?
Another great way is to simply look at where implied volatility is with regard to recent history.
A common formula used is “IV Percentile,” in which the option is ranked in terms of percentile based on how cheap or expensive it is relative to the previous year. So, if the option has an IV Percentile of 15, then only 15% of the time over the past year has it been cheaper.
It might be a decent opportunity to buy volatility.
Bottom Line
This is one of those areas in trading where some traders just take to it.
We recently talked about the similarities between trading and professional poker on the blog.
In this case, I’d say making bets on economic data releases is more akin to sports betting. You’re given a spread (price) and nearly immediately following the event you either win or lose.
It’s completely different from the vanilla technical day and swing trading that most of our readers do on a daily basis.