Analysis: Political news in trading

In our latest thought piece, Andrew Saks McLeod asks Acuity Trading’s CEO Andrew Lane about the role of political news in the realm of trading and how news sentiment tools can help traders weather the storm of political instability.

Why do political news stories have such a significant impact on the markets?

Markets like stability, predictability, and continuation of a policy that allows companies to focus on building good businesses. Unfortunately, most successful economies also have election cycles, where potential leaders push forward radical plans to differentiate themselves.

This political thumping of the chest can often bring social issues to interact with economic issues. Business taxes, legal frameworks, trade agreements are often examined or altered, which leads to uncertainty amongst business. If businesses are unsure of the future they will hold back on future investments.

But let’s not forget, this can swing both ways. Perceived business-friendly politicians can be positive for an economy. And, even an act of war can force the price of oil companies up.

These events lead short-term investors to buy and sell based on political fortunes, believing the future of the economy is at stake.

Is a negative impact more severe than a positive one?

I have always found this question interesting. Generally what research has found is that when markets are trending downwards, negative news has less impact. Conversely, a positive news story in a negative market will exaggerate the move in the price of an asset.

How does the market recover from a negative political announcement like the recent one by Theresa May?

It is possible the market had become over buoyant with good economic figures released over the last month. Traders had taken their focus away from BREXIT, and Theresa May simply burst that bubble and brought BREXIT back into focus.

From another perspective, it could be that Theresa May was perceived as simply shooting the first broadside towards Europe in their negotiations. Conversely, the market under reacted, because they didn’t believe Britain was heading towards a hard BREXIT.

Either way, markets tend to overreact to market moving stories, and it is important that traders follow the prevailing long-term sentiment in the market.

Can markets ‘see through’ attempts by politicians like Theresa May last week to make more confident statements to stabilise the markets or do they have little impact?

Certainly, Theresa May will use her statements to assuage markets or even to talk down prices of GBP to improve the competitiveness of sterling. However, to understand the impact of a statement, first we must measure the news volume surrounding the issue.

Secondly, we must measure the opinion in the news. Is it negative or positive towards a statement? Only then can we understand the impact of a statement. One thing is for certain, we must avoid reading only headlines as that is just one journalist’s opinion.

How can traders use sentiment in their trading strategy?

The good news is that economic and political uncertainty creates more volatility in the market and it is this volatility that creates trading opportunities. In any trading strategy that involves monitoring news events, a trader must understand the underlying mood of the market for the reasons I have already mentioned.

However, we are often unaware of big shifts in the mood in the market or how a story is affecting the market until after the markets have reacted. For this reason, we must use News Sentiment to understand the shifts in opinions as they start to occur. With the volume of news now published, this is very difficult to do by traditional means.

Big shifts in market mood can often predate changes in price so tools like the ones Acuity offers means that traders can identify changes in sentiment early.

News Sentiment is a fantastic tool to confirm many trading strategies. For example, I have a friend who trades oil on a passive basis. He likes to trade off bounces from support and resistance levels.

Traders can always identify support and resistance levels in price, but this particular trader filters these levels with News Sentiment. If he feels the price is approaching a resistance level, he will look to see if there are high levels of negativity or positivity.

The idea being that if the market is overly positive it may ride through the resistance level, if there is a high level of negativity then he will expect a bounce off the resistance level. A simple but effective trade idea that lowers the risk for him.

Conversely, using the same oil trade example, you can use News Sentiment to manage your trades by using negative sentiment as your next resistance level instead of price once it has successfully passed through a resistance level. Combined with a trailing stop loss I am told this is a very effective trade strategy too.

Can News Sentiment go as far as predicting who the next US President is going to be?

News Sentiment extraction is analogous to a continuous election poll. We are essentially taking a very large sample of the media, and measuring what they feel towards presidential runners. Polls, on the other hand, tend to take a sample of potential voters, whether that is online or by phone. Of course, polls are widely followed by the media, so News Sentiment also takes these polls into account.

So all though nothing can accurately predict who is going to win the presidential race, News Sentiment can accurately tell you who the media believe have the advantage in the race, which in turn spurs volatility in the market.