Backtesting News-Driven Triggers

Three primary categories of triggers exist which drive asset prices:

  1. News-driven triggers – a pre scheduled economic event as a trigger for trades. 
  2. Price-driven triggers – a price movement in one market triggering a move in the same or another market.
  3. External news – an unscheduled, unexpected piece of news that triggers a trade.

In this section, we will address the first category: news triggers.

Economic Events (News-Driven Triggers)

Economic events are accessible through an economic calendar, a tool that tracks worldwide economic events released by government agencies. The economic calendar is repeatedly updated through live feeds and provides pure statistics of the event without ancillary analysis. Government agencies’ release of data has a profound impact on the Foreign Exchange (or Forex) Market, which determines the exchange rates for currencies across the globe. Events are scheduled in advance, whether it be speakers of the Federal Open Market Committee or of government councils. Traders, therefore, have access to the same information as large investment companies and trading firms. They may analyze economic indicators to evaluate their impact on movements in the Forex market.  

In order to effectively analyze economic events, traders must be able to read economic calendars. An example of an economic calendar is shown below in Figure 7. The calendar shows all the details of the release from the release time to the country and currency that this event belongs to. Each economic event is ranked in terms of importance and volatility as a first, second, or third tier event. Third tier (!!!) data are the most important and frequently monitored by traders, as they have the highest potential impact on the currencies and commodities market for the particular country. Traders can leverage this market reaction to make profitable trading decisions. Many economic calendars have an option to filter economic data, so traders may choose to view only tier three data. Economic calendars will automatically update the actual values of the events. If there is a deviation from the actual and expected release values, traders can capitalize on the volatility in the Forex and Futures markets to make a profit. To learn more about economic events, reference this eBook

Traders can evaluate economic reports to generate a return by analyzing the expected and actual release values. For Manufacturing PMI in the United States, as shown in Figure 7, the expectation is 48.0 and the actual number is 49.6. Many tend to believe that an increase of 1.6 is relatively insignificant. However, the expectation for this event is accurate on a regular basis. This deviation by 1.6 is unexpected and constitutes a magnitude of surprise of Much Stronger

Given the deviation, traders must be able to identify instruments and markets to trade. Backtesters can allow traders to test historical outcomes for similar United States Manufacturing PMI releases and evaluate the impact on other instruments like oil and gold. The live newsfeed of economic events can be stored in the backtester’s data handler. Given certain economic releases and forecasts, the backtester can provide traders with historical results after certain events. For example, given a magnitude of surprise of Much Stronger for the United States Manufacturing PMI, the backtester may notify traders that 8 out of 10 times the EUR/USD increased following this event. The backtester will generate a news-driven trade idea for EUR/USD with a historical success ratio. The backtester’s strategy tools will then develop the risk/reward ratio, profit target, and stop loss recommendations to determine both worthwhile and unreasonable trades.

Traders find economic events enticing because of their volatility and correlation with various asset classes such as currencies. Effective backtesters can analyze economic calendars for traders and provide them with robust analysis of the Forex market.

Backtesting can be done either by programming in python, other coding languages, or by using user interface products like BetterTrader’s backtesting system. These preprogrammed tools are limited in comparison to self-programmed software, but they are readily available and do not require knowledge of coding. To further explore news-driven triggers, read this case study on the unemployment rate and its effect on the S&P 500.

Continue to the next part of our backtester series here.