How to Trade the News

Asad Dossani

News moves markets, sometimes significantly. Most traders have firsthand experience of news impacting their portfolio. You may find the perfect bullish trade setup, only to have some bad news sink the stock lower. This problem is worse for those using technical patterns, indicators, or systems for their trades. Past prices help you predict future prices, but only up to a point. Past prices don't predict news.

Nonetheless, you can find ways to profit from the news. How do you incorporate news into your trading strategy? First, it's important to distinguish between scheduled and unscheduled news. Scheduled news includes RBI or Fed announcements, company earnings announcements, etc. While the content of the news is unknown, the timing is known in advance. You can plan for it. Unscheduled news occurs without warning. You can't plan for this. But you can react appropriately.

There are two approaches to trading the news. The first is to predict the content of scheduled news. If you think the RBI is going to raise interest rates, and the majority of the market believes otherwise, you can trade accordingly. You can take a position that would benefit from a rate increase. For this approach to work, your view must differ from the consensus view. This is because the market prices in the consensus view.

The second approach is to trade the news once it has occurred. This works for both scheduled and unscheduled news. After a news event, you observe the market reaction and ask yourself if it makes sense. If the market has a large fall, but the news was minor, the market is likely to rebound and change direction. You can make money trading this scenario. On the other hand, if the market reacts weakly, it will likely continue in the same direction. Again, you can make money trading this scenario.

How do you know if the market moved too much or too little? A significant amount of intuition is needed. The more you follow markets, the more you learn how it reacts to news. And the better you can judge whether a reaction is too large or too small.

It turns out that the derivatives market is a great place to apply these approaches. You can hone your trading skills through practice. If you are new to this, I have prepared a short guide on how to get started trading the derivatives markets. And the next time a big news event strikes, you'll know exactly what to do.


Market Notes

Rollovers Indicate Short Covering, Can Nifty Resume Its Upmove?

The Nifty 50 Index ended another expiry near its all-time high. For the past three expiries, the Index has closed at new highs. Last time, in our April expiry rollover report, we saw lower-than-average rolls with declining open interest (OI). We also saw momentum lose ground, which turned out to be true to some extent.

The Nifty did close the May expiry up 1.79%, but almost all the gains came on the last day of the expiry. If we exclude the last day's trading, the index ended the expiry flat. So first, let's look at the index performance up to the day before expiry. Then let's address the final trading session of the May expiry.

But first, what is rollover?

Rollover refers to traders shifting their future contracts positions from the near-month contract to the next-month contract. For example, Nifty traders are shifting their future contract positions from the May expiry to the June expiry. Here's the formula:

Rollover % = Next Month OI (M2)
Near Month (M1) + Next Month OI (M2)

The rollover formula tells the percentage of contacts rolling into the June expiry from the total contracts outstanding from the May and June expiry.

This month, Nifty rollovers stood at 73%, which is higher than the previous three-month average of 68%. Open interest (OI) was 2.00 crore contracts compared to 2.09 crore in the previous expiry. Open interest in absolute terms decreased 9 lakh, but the rolls were on the higher side.

But a point to note here is that the number of contracts outstanding in M2 (June contracts) at the end of the May expiry was 1.91 crore. This is lower than the number of contracts outstanding in M2 (May contracts) at the end of the April expiry. That is, there were 1.98 crore outstanding May contracts at the end of the April expiry.

Although we see higher-than-average rollovers, the OI in absolute terms in on the lower side. So the higher-than-average rolls are due only to the base effect.

M2 M1+M2 Rollover %
27 April 1.98 crore (May Contract OI) 3.03 crore 65%
25 May 1.91 crore (June Contract OI) 2.61 crore 73%
Source: NSE Website

The Nifty closed the May expiry flat (excluding the last trading day). It was well indicated in the previous rollover report that the index had lost some momentum.

Now, on the last trading day, the index rallied 149 points. But the OI decreased 24%. A rising index with decreasing OI suggests the last-day jump was a 'short covering rally'. From mid-expiry, the index declined 165 points with decent OI addition. But the OI that was built up during the fall has faded as indicated by the short covering rally on the last day of the expiry.

With this, we will have to wait for new OI to build up to form a clearer directional view of the Nifty.

Nifty Options Matrix (in Contracts)

Nifty Options Matrix (in Contracts)

On the options front, the Nifty put-call ratio (PCR) stood at 1.06. A reading above 1 indicates more put sellers than call sellers. More put sellers suggests option sellers don't expect the index to go down much.

The highest OI in calls stood at a 9,600 strike with 33.93 lakh contracts. And the highest OI in puts stood at a 9,300 strike with 38.08 lakh contracts. Based on this, 9,600 can act as resistance and 9,300 as support in the June expiry.

For the past three expiries, the 9,000 put and 9,500 call had the highest OI. But this has now shifted upwards to 9,300 put and 9,600 call, which favours the bulls.

Now let's look at the Nifty chart. The index traded on a volatile note during the May expiry. It shot up 222 points during the start of expiry to a high of 9,523. It corrected 165 points from the mid-expiry and finally rallied 149 points on the last day of the expiry.

The negative divergence indicated by the RSI indicator brought a decent correction. But towards the end of the expiry, the indicator found support from the 50 level as indicated by the green line in the chart below. As a result, the index rose to resume its up move.

Nifty Index Traded Volatile for the Expiry

Nifty Index Traded Volatile for the Expiry

Although the rolls were on the higher side, the OI decreased in absolute terms and the Index ended the expiry positive. This indicates short covering. For the moment, the bears are out of the market. But we will need a confirmation from the price action in the coming few days of the June expiry. The other data suggests the index will resume its up move. So the first few days of the June expiry should give us a clearer picture. Watch the OI and price action closely...

From The Market Wizards...

"Good traders liquidate when they are wrong, great traders reverse when they are wrong." - Jack D. Schwager

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3 Responses to "How to Trade the News"
Gaaneysh Mattte
04 Jun, 2017
1) Pl clarify or elaborate @ Rollover % formula. I have got doubt about the Numerator. You have stated as Next Month OI (M2) in the Numerator. Actually, Rollover % means % of contracts shifted to next month expiry? Is it right?. Thus, Near month OI (M1) when shifted to or rolled over to next month should be indicated in the numerator. Is it correct? PL CLARIFY. 2) Pl elaborate the phenomenon of Short covering Rally.Like 
Rupayan Roy
26 May, 2017
Very nice investment opportunity.Like 
Abhay Gore
26 May, 2017
Great analysis of Nifty movement in May series. Quite impressive. You have mentioned to watch Open Interest & Price action closely in the beginning of the June series. Can you suggest from can one get the data on open interest on Nifty & individual companies? Regards. Abhay.Like 
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