Imagine this scenario: You sit down to check the markets. You review recent price movements and consider potential trade ideas. What happens next?
- You may quickly stumble upon what seems like a great trade idea but feel uncertain because it appears to be too good to be true.
- You spend 30-60 mins delving deeper into the markets only to find yourself trying to figure out what to do next.
- Or you're putting in a lot of effort and mental sweat to craft a high-odds trade, but it's not working out.
Does this sound familiar?
In this type of scenario or at this point, there is the temptation to skimp on crafting a trading catalyst and game plan but rather jump straight into a pattern or similar route. Right? But, when you do this, you end up inadvertently killing the golden goose. How? Let me explain:
As a trader, you enter into a trade to benefit from price movements. However, without an underlying catalyst, there’s no reason for a market to move or 'react' as is often the case in response to an economic release. A trading catalyst refers to an event that triggers a significant change in the price or volume of a financial instrument, whether it’s stocks, commodities or currencies.
However, you need to know that price movements are not limited to obvious events such as the release of an economic dataset. Often the uncertainty surrounding how a market will react to an upcoming release keeps many professional traders out of the market. This creates a low liquidity environment that is subject to fast spike increases and decreases in price.
In the upcoming video, as an illustration, you’ll see how market participation evaporates upon an important news release. But, the important question is, how can you uncover trading catalysts outside of news and data releases?
Three Examples of Catalysts to Improve Trade Outcome Odds
Here are three examples to assist you in thinking through possible catalysts.
- A counter move occurs in the market you trade when an XYZ market opens. Not an elaborate idea, so not a large payer, but it's a catalyst that leads to tradable price movement. In my case, I exclusively trade AUD/USD futures intraday. And, whether it’s the futures or spot FX market, both move in the same direction. When you think about the role of currency markets and who the large players are (commercials and hedgers), you can appreciate the relationship currencies have with other markets. When stock markets around the globe open and close, the AUD/USD is subject to move. The reasons go beyond this article. However, relative value and trading across exchanges is common in the institutional space. When one market opens or closes, it impacts positioning in a currency market.
2. Lifting COVID restrictions in China is a boost economically. A move up in markets, even if short-lived, is likely, but difficulties of investing in China mean traders look to express the trade via a proxy market. Look for the idea, followed by the proxy market to move in tandem. The second idea is more advanced; hence, it provides a higher payout catalyst to the first idea. In the case of the AUD/USD, there are institutions and hedge funds around the globe that will express their Chinese Stock Market investments via AUD/USD.
3. Another scenario is a situation where the market considers a rate hike as a foregone conclusion even as all other factors also point to an increase in cash rate that will be bullish for the currency. In this type of scenario, forward-thinking traders consider the rate hike as already priced as it was before the official announcement and, therefore, enter short on the release. When this type of situation happens, after an initial push-down in price, you can opt for a catalyst as a short squeeze.
Watch a Real-Time Catalyst in AUD/USD:
Using live trading mentoring as an illustration, say you find an analysis that produces a hypothesis that suggests an upward move in price. What’s the catalyst?
In the video below, you can watch the crafting of a hypothesis followed by waiting for a catalyst to move the price before the trade is entered.
Short sellers, who entered the trade responding to unemployment data only to find themselves the target of a short covering rally, act as the catalyst to spark an upward movement in price as per the trading hypothesis.
Please note that all three examples given in this article show that trading catalysts can vary from extensively researched data to simple observations. Start with simple catalysts to build up your confidence and momentum.
Stick to the simple ones, and you'll find yourself progressing naturally towards uncovering more sophisticated catalysts.
