One of the things I always emphasize when I start working with a coaching student is that the markets tend to behave much more in response to the psychological than to the logical, particularly in the short to mid-term. Many retail traders seem to fail to account for the relatively high levels of emotional reactivity in the markets in making their trading decisions. As an example, have you ever noticed that it is not unusual for a stock price to dip or drop right after an earnings announcement even if that announcement was not at all bad?
I am reminded of a situation that occurred several years ago. A fellow who had come to one of my seminars called one day and told me he had just bought a hundred or so short call option contracts on a company he followed and that the company was going to announce earnings the following day. I was astonished and asked where he learned to do that because it certainly wasn't from me. He responded that he knew the earnings were going to be really good. When I asked how he knew and whether he had insider information he said no, he just knew the earnings would be good. Sure enough, the earnings weren't bad, in fact just under the analysts prediction and the stock tanked. Why? I guess we can never know for sure, but that kind of action seems to occur with regular frequency when the earnings miss some analyst's predictive guess. My acquaintance lost a bundle and stopped trading.
News can certainly be a catalyst to price movement as well. As with so many of the old saws, "buy on the rumor, sell on the news" has a basis in experience. I would suggest the better approach might be to buy on the rumor and sell before the news. What really seems to occur, using the example of an earnings announcement as upcoming news, is that there is speculation, sometimes wild speculation as an earnings announcement approaches. As I am writing this article on Wednesday afternoon, August 5, 2009, for example, AIG is up over 60% before its earnings announcement on Friday. One squib I read indicated that was because analysts anticipate it'll swing to a profit. Another analyst suggested the jump was caused by scrambling shorts buying to cover positions and said there was " ...certainly no news to account for it." In either event, it is clear that speculation is extremely high on the upcoming news. Shorts are clearly fearful and longs are basking in fulfillment of their greedy side. What will the announcement be? I certainly don't know, but I do know that once it is made, we will have the answers and at that point, the questions will have been answered. The guesswork will be over and the predictions either fulfilled or they will have fallen by the wayside. In many instances (though certainly not all) once the reason to speculate is gone, the wild swings are less likely to occur. For that reason, I personally try to be aware of the dates when earnings will be announced and may make a play going into the announcement, but exit before the actual announcement.
Another example of market reaction relates to time of year. The point is analogous to the preceding discussion in that it can also relate to earnings season. Many companies announce their earnings in the month following the end of each calendar quarter, for example. So, for example, when the first calendar quarter ends in March, traders are looking forward to the earnings announcements in April. Speculative interest rises and "bets" are being placed as to how good earnings will be; whether the earnings will beat the last quarter, or the same quarter a year ago, or some analyst's guess (prediction). Once the earnings are announced, the answers are at hand and the reasons for the speculations are gone. The questions have been answered. Now, as the calendar reaches May, there is no immediate excitement about upcoming earnings reports for those companies that have just reported so, absent some other news, things are more likely to be more peaceful. The same situation applies in August, October, and February.
As with so many things in the market, I don't mean to suggest that these are hard and fast rules. In my view, they are just factors about which it may be helpful to be aware. If we take October as an example, think of the crashes and drops the market has suffered during that month over time. Last year, as one example, the Dow fell over 2600 points from the October high to the October low.
by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
All Rights Reserved
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