Countless news outlets keep you up to date on the latest global events all the way down to your local news.
Of course, as a trader it’s important to keep on top of the major stories. You need to know what’s going on.
But instead of immersing yourself in the story of the day and then thinking about how that should play out in the market, you need to switch that the other way.
That is, you need to focus on how the market reacts to the news and not what you think the market should do because of the news.
As I’ll explain, if you wrap your head around this simple distinction, it will make a massive difference to your success as a trader…
Markets Move on
You only need to go back to the subprime mortgage disaster of 2007 to 2009 to see what I mean.
If you based your decision-making solely off the news, there’s no way you would’ve bought stocks during that period.
Think of the Lehman Brothers collapse and the record-high foreclosures. The U.S. government even took over Fannie Mae and Freddie Mac to ensure their survival.
There was so much bad news everywhere that you might have considered not buying stocks again for years… if at all.
But as you can see in the chart below, the market bottomed out in March 2009 and rallied from there…
S&P 500 Index
Source: eSignal
Had you based your decision on the news of the day, you would’ve missed one of the greatest bull runs in history.
The Relative Strength Index (RSI) in the bottom half of the chart (left orange circle) showed that buying momentum was returning with a vengeance…
Put simply, by that stage the market had already moved on. That’s because markets always look to the future.
You can see a similar pattern (right orange circle) with the COVID pandemic.
At the time the market was in free fall. But a sharp reversal in momentum as governments worldwide pump-primed their economies saw the markets rebound strongly.
Stocks and Sectors Too
But it’s not just big macro events where you see this effect play out…
For example, you might see some positive news come out about a particular sector. And based on current projections, the sector is likely to grow strongly the coming year.
Yet when you check out the stocks in that sector, you might find that they barely react to that news story.
That’s because the news is already priced in…
Likewise, we’ve all seen examples of how after making a record profit, a stock’s price tanks. It can be immensely frustrating.
Had you bought into the stock based on the upbeat profit news, you could end up with a losing trade.
Again, watching how the charts react to the news story – rather than thinking about what should happen based off of that news – could save you plenty of headaches as a trader.
Not to mention dollars…
Reactions Can Change
You need to focus on how the market reacts to the news. But you also need to be acutely aware how that reaction can change…
You only need to consider the Greek debt crisis almost a decade ago. Back then potential defaults by Greece were all over the news.
As each piece of debt came due, there was nonstop speculation about what would happen to the global economy if Greece defaulted.
It led to some massive swings in the markets…
But today you won’t find a story about Greece’s debt anywhere.
We’ve seen similar things with the ailing property market in China. One day it’s a big story, then the next the market moves onto something else.
That’s simply how the market operates. It does what it’s going to do irrespective of what you think it should do based on some news story.
And that’s what you’ve got to wrap your head around…
Trading off how the market reacts to the news will greatly enhance your odds as a trader.
And help you bank some tidy profits.
Happy trading,
Larry Benedict
Editor, Trading With Larry Benedict