Trading On News

No closing video today, I am out of town. Here is an excerpt from MY BOOK

You may be wondering what a chapter on news is doing in a book about technical analysis. A technical purist would take a closed-minded approach, indicating that “fundamentals don’t matter because the chart tells all.” Just as many fundamentally oriented managers express their perceived disdain for technical analysis (“Reading charts is like reading tea leaves.”).

The practical truth is that participants place their trades based on analysis of both fundamentals and technicals, and to completely ignore either is foolish. Don’t start thinking that I’m talking out of both sides of my mouth here – 95 percent of this book is dedicated to technical analysis, and the other five percent to this chapter. All of my timing decisions are based on price, not news or fundamentals.

Human nature is to ask questions. People want to know the “why” of those things they don’t understand right away. The markets are no different. All of us try to assign order to chaos, and crowd behavior in reaction to news frequently is very chaotic. We often do this instead of focusing on why a stock has already moved.

Personally, I want to know why people buy stocks in much more general terms. More importantly, though, I want to anticipate what their next move might be, when it may occur, how much risk to take and how much can I make if my analysis is correct.

In the market, the answer to why isn’t always easy to understand. Fortunately for traders, it doesn’t always matter. Interpreting news and committing capital based on our views of those events is very one- dimensional, just as monitoring the actions of just one participant is one-dimensional. But correctly interpreting human nature and crowd behavior is really what understanding technical analysis is all about. What causes one participant to buy or sell has very little significance beyond a couple of days.

It has been shown over and over again that no one is bigger than the markets — remember Long Term Capital Management, Amaranth Partners, Bear Stearns and some of the other large “smart money” participants who went down in flames? If a very large participant attempts to move a stock – or even the market — it can be accomplished for short periods of time, but it is very risky because it puts that institution in a large and likely difficult-to-liquidate position if the market moves against them quickly. Without proper risk controls in place, even the largest market participants can be forced out of business. Incidentally, many of the stocks you will trade successfully with a short-term timeframe are the recipient of a participant attempting to move prices in a particular direction.

Fundamentals Do Make Market Participants React
Fundamentals do matter because they are often the catalyst that causes a large group of participants to take buy or sell actions. There are many technical traders who buy breakouts or sell a stock short as it breaks below support. On a larger scale, there are more participants who buy and sell stocks based on their perceptions of a company or its products.

News releases are the biggest catalysts for participants to reevaluate their thinking about a company and make position adjustments based on expectations and ideas of value gained from the new information. News triggers emotion, and that emotion triggers actions that can be measured on price charts.

In college we are taught to evaluate a company based on its fundamentals, while technical study is given almost no attention. I learned a great deal in business school, but very little of it has helped me to become a good trader. What has helped me attain trading success with fundamental information is an understanding of when it makes sense to pay attention to these catalysts as it gives me insight into the psychology of the fundamental crowd.

I do believe that “the market knows all” and also that “news and surprises tend to follow the direction of the primary trend.” One of the principles of technical analysis is that the market discounts the past and anticipates the future. Whether it is anticipating where the economy will be in six to twelve months or the lifecycle of a business product, the smart money attempts to position its holdings to take advantage of emotional responders to the news when it is released. Financial analysis is big business, and institutions pay millions of dollars per year to access information based on in-depth analysis of what the future may hold for the economy, a market sector or an individual stock – and for good reason. It is the goal of an institution to accumulate shares before the “good news” is known to the majority of participants so they can be in a position to sell shares as price and volume expand.

When positive news is released, it is usually the public who buys from professionals. When negative news is released the coin flips, and professionals are often the buyers from the emotional public. The smart money buys temporary setbacks in a bull market and sells their long positions on short-term rallies in a bear market. It is common for strong markets to ignore negative news (“climb a wall of worry”), while weak markets react quickly and severely. Bear markets tend to ignore positive news and slide down a “slope of hope” or react with limited enthusiasm.

Today’s near-instant dissemination of information can be an undisciplined trader’s worst nightmare. Inexperienced and uneducated market participants — the “dumb money” — are more likely to be motivated by news headlines, chat room gossip, etc., and the market dutifully punishes their lack of thoughtful preparation with losses. Simply put, professionals anticipate while amateurs react.

more to come….