The market trades the surpriseJudge every number against what was expected.
The market doesn’t trade the news. It trades the gap between what everyone expected and what actually came out, which is why a bad number can lift a currency and good news can get sold.
Expectations are already in the price
The lesson on the key interest rate showed that a rate decision moves a currency through its surprise. The same holds for every release, and it explains many reactions that look wrong at first.
Markets look forward. Before a release, traders already have expectations, built from earlier data and from what central banks have said, and they position for them. By the time the number comes out, those expectations are already in the price. That is what priced in means.
So when the number arrives, what counts is how it compares with what was expected, far more than whether it looks good or bad. This is where many retail traders go wrong. They judge a data point in absolute terms, while institutions trade it against what was already priced in.
A bad number, a stronger dollar
Here is a classic example. The US unemployment rate rises from 3.7% to 3.9%. That sounds bad for the dollar, because more people out of work usually means a weaker economy.
But say the market was braced for a much bigger jump, to 4.2%. Against that expectation, 3.9% is better than feared. Traders who had positioned for a weak report have to adjust, and the dollar rallies on the relief. The number was bad. The surprise was good.
The market was braced for higher unemployment
Up from 3.7%, but better than feared
Relief, not the obvious bad-news reading
Where the expectation comes from
For most releases the expectation has a number: the consensus forecast, the middle of the forecasts that economists submit before the release. The Economic Calendar shows it next to each release, together with the previous reading.
The consensus is 1 number made from many forecasts, and the spread around it matters too. A reading slightly above the consensus can still sit inside the range most forecasters expected. A reading beyond almost every forecast is a real surprise. Try it below: each dot is 1 forecaster and the consensus is 3.0%. Drag the actual reading through the dots.
Above the 3.0% consensus. Higher than 16 of 20 forecasts.
Good news sold, bad news bought
This is how you get moves that look crazy at first. Good news gets sold, because it was less good than hoped. Bad news gets bought, because it was less bad than feared. And in quiet markets, a real surprise can cause an outsized move.
It works the other way too. If everyone expects weak inflation and gets weak inflation, there may be almost no reaction, because there is no surprise. But if the market expects inflation to keep falling and it suddenly ticks higher, that changes everything. The reading itself can be modest. What matters is that it breaks the path the market expected.
This matters most around the big events: the Fed’s FOMC decisions, inflation releases and geopolitical flare-ups. Price won’t reflect the data in isolation. It reflects the shock, or the lack of one, against what traders had built into their positions.
3 questions before every big release
Before any big release, ask yourself 3 questions. What is the market expecting? What is already priced in? And what would be a real surprise, in either direction?
Write the answers down before the number comes out. Then you aren’t working out what a reading means while price is already moving, and you can tell straight away whether the reaction fits the surprise or tells you something new.
Don’t judge a number on its own. Judge it against what the market expected.
In short
- Markets look forward. Expectations built from earlier data and central bank comments are already in the price before a release.
- What moves price is the gap between expectation and outcome. A rise in unemployment can lift the dollar if the market feared worse.
- Before every big release, ask what the market expects, what is priced in and what would be a real surprise, in either direction.
Key terms
- Priced in
- When the market already expects something, so it barely moves when it happens. Only the surprise moves price.
- Consensus (forecast)
- The average forecast of economists for a data release. The market reacts to the gap between the actual number and the consensus.
- Forecast
- The expected value of a data release, usually the consensus of economists. Compared with the actual number to measure the surprise.