How To Trade The News — Rule 3

Background: Markets have long sought to generate alpha from policy developments. The 24/7 media cycle, turbo-charged by social media and algorithmic high frequency trading, accelerates execution cycles and generates information overload which complicates strategy formation.

This blog series articulates rules for designing news-related trading strategies. They apply across all asset classes and financial instruments. Posts include examples and concrete data.

If you are following Rule 1 (Be Objective) and Rule 2 (The Trend is Your Friend) in previous Traders’ Insight posts, and if you have a mechanism for following the news cycle, you might think that being strategic is busy. Sadly, this is not the case. Being strategic can be very difficult in a world of information overload and a 24/7 news cycle turbo-charged by social media.

This post explains why nearly infinite access to the news cycle makes it hard to be strategic. It also provides some suggestions for strategies to combat information overload.

Information overload interferes with strategy formation.

Trading the news often looks like a Cold War arms race.

On the supply side, a nearly infinite flow of information comes from policymakers around the clock. New developments are posted on websites while you sleep. Massive volumes of documents and statements are dumped into the news cycle around key inflection points like summits and hearings. Reporters seek out leaks and hints about decisions, creating potential future exposure to shifts in the policy profile. Everyone has an opinion, from bloggers and former government officials to newsletter writers that populate your inbox regularly.

Demand for access to information from capital market participants prompts significant investments in technology infrastructure that can decrease the latency of information transmission. High frequency traders and algorithmic traders track headlines and Twitter feeds so that they can execute trades on a nanosecond basis. Their goal is to be the first and the fastest to react to policy shifts under the theory that the first mover reaps the highest market alpha. Risk managers and portfolio strategists require the most updated information in order to generate more accurate, realistic scenario analysis that facilitates smarter risk assessments.

By tracking the news cycle intensively, the goal is that technology can help spot inflection points faster, leaving the professionals to focus on strategic issues used to program the next set of execution instructions. The irony, however, is that the noise of the news cycle creates distraction. It is easy to slip into the teenage game of telephone, as traders and media outlets ask “did you hear about” the latest statement, outrage, or natural disaster.

Significant, non-stop access to information about policy also generates the temptation to convince people (including, of course, risk managers that must approve a trade or a trading strategy and related risk limits) that you know what you are talking about. You can tell when someone has become addicted to the news cycle because they know every arcane detail of a situation.

Finally, it is important to note here that trading the headline is far from fool-proof. Headlines can be misleading. They can overstate a situation. They can focus on the gossip while burying the substantive detail that makes a difference in the markets. Most importantly, while everyone in the market is focused on the headline, alpha can be generated by reading and understanding the detail.

Case Study: Brexit in February 2019

Earlier this year, many will recall the UK Parliament rejected for the first time the Withdrawal Agreement negotiated by Prime Minister May and the European Union. The UK Parliament has now rejected the Withdrawal Agreement more than once of course. But in early February, they had only voted against it once. After meeting with Irish Taoseach Leo Varadkar, Council President Donald Tusk released a statement.

Do you remember the statement? Few do. Why? Because the media cycle instead was dominated by a strategic talking point uttered by President Tusk at the press conference. If you follow Brexit at all, most readers will remember President Tusk saying bitterly that “there is a special place in Hell” for Brexit promoters who do not have a plan for exit.

The next 36 hours in the media cycle were dominated by this colorful comment. Blogs were written. Countless hours were spent in broadcast media talking about (and chuckling over) the comment. Countless more hours were spent by trading professionals repeating the quote and the story, many with the apparent intention of portraying themselves as an insider close to the action, when in reality the talking point had been plastered all over the global news cycle. Brexit supporters responded, thus extending the news cycle and the argument over this statement, which has zero impact on the actual substantive issues.

The media cycle and the ensuing gossip stream distracted from the substantive hard line position taken by the EU. President Tusk’s statement made the following point clearly and succinctly: “the EU27 is not making any new offer.” This set in motion the creation of two irreconcilable positions: a majority in the UK Parliament disapproving the Withdrawal Agreement and seeing a renegotiation and a strong position in the EU that no renegotiation was on the table.

Guess what else occurred that week? Throughout the week, various policymakers in London and throughout Europe began putting into place policies designed to minimize the disruption on the first working day of April in the event of a No Deal Brexit.

As the chart above illustrates (created by our patented technology), by the end of the week, action had outpaced rhetoric. The detailed composition of that action shows technical agreement between various EU entities (EU Parliament, European Securities Market Authority) and UK entities as well as individual actions by the UK government all designed to implement a No Deal Brexit. For more detail, please see this blog post.

The 24/7 news cycle and all the chatter distracted attention from the inflection point that occurred that week. No Deal Brexit became the dominant policy trajectory that week and has remained so to this day.

How To Remain Strategic Amid Chaotic News Cycles

If you have a position that hinges on a policy or geopolitical event, it is crucial to avoid getting distracted by the noise of the news cycle. Take the following steps consistently:

  1. Stay Focused and Disciplined: If your position is focused on a specific issue, avoid spending time on ancillary irrelevant developments. Yes, the “special place in Hell” talking point was salacious. But was it really relevant to the policy trajectory regarding cargo inspection standards at Calais or equivalence decisions regarding clearinghouses? No. Focus only on developments that directly impact your position.
  2. Use Technology Wisely — Capitalize on Enhanced Cognition: Seek out technology solutions that deliver the ability to focus on concrete policy activities rather than just regurgitate aggregate search results from the media cycle. Advanced Natural Language Processing (NLP) makes it possible to delegate reading to a computer which can process much larger quantities of information faster than any human. Wise use of this technology to support trading-related research delivers “enhanced cognition” by which human beings can connect the dots faster and better than a computer.

We know that artificial intelligence and machine learning is all the rage right now. But the reality is that AI is in its infancy, literally. AI systems cannot yet generate the kind of connections between related concepts as well as humans. So a human using NLP-based solutions can still outperform the current generation of AI systems. This may not last, of course, since AI systems are being trained by larger data sets daily. But for the moment and over the medium-term, those that use systems that deliver enhanced cognition will be able to generate alpha from trading the news cycle even if they do not use high-frequency trading platforms.

These are not easy steps to implement. We know that. But the ability to trade the news responsibly requires being able to distinguish between the chatter and real activity. Failure to implement these rules exposes you and any client funds you manage to policy risks. Most importantly, these policy risks are neither random nor unexpected. They can be measured and managed, with discipline. The reward for early adopters in particular is alpha generation based on concrete facts rather than a race to chase headlines.

Barbara C. Matthews is Founder & CEO of BCMstrategy, Inc., a technology company deploying patented and proven processes for measuring public policy risk and anticipating outcomes based on those measurements. You can find more information about the company here: She has served as a senior policymaker and Senate-confirmed diplomat in the United States government as well as a senior strategist and advocate for the global banking industry. An earlier version of this article appeared on the Traders’ Insight blog hosted by Interactive Brokers.

Quantifying cross-border policy risk using patented tech Founder & CEO #Data #NLP #geopolitics #DigitalCurrency #PredictiveAnalytics

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