Wednesday, September 28, 2011

News - Trade'em or Fade'em?

Having commented lately on the influence the news flow from Europe has on the market and how sensitive this market is to those headlines, I received a very good question which made me think that I should have written on this topic long ago. Here is this, very valid, question:

"Vad, I am trying to reconcile these comments (on market sensitivity to Europe news - V.G.) you made in your trading log and on your Facebook page with the idea that you promoted many times before - that the news is usually priced in by the past movement and by the time the news is known to everyone it's too late to act on it, and a trader should start looking for info-price divergence to fade the news. Sure enough, I've seen many times that this idea worked like charm - and I do see now how market reacts on any peep from EU, just as you suggest. Could you comment on this contradiction?"

To be able to tell these situations apart, we must define two different kinds of news from the point of view of interaction between news and price.

First, and the most traditional for the "normal" market developments is what I call FSN - Fleece Sheep News. This is exactly what it sounds like. The scenario is old as the market itself. You've seen it 1000 times, and quite possibly were on a receiving end of it at some point early in your trading career. Smart Money starts buying while no one's even looking, it figures out the coming developments and accumulates before these developments become common knowledge. Price moves up slowly at first, then speeds up as an advance starts attracting attention and new passengers climb aboard. Finally the news comes, price spikes sharply and Smart Money feeds previously accumulated shares into such euphoric spike. No more buyers left, the last crop of late arrivals is left holding the bag as the price declines - and it does so against the background of a good news, with no single negative word, all to the amazement, resentment and accusations of manipulation by those who never bothered to study how the market really works... Examples of such news is introduction of a new technology, new product or drug, changes in demand, general industry trends, etc - things that keen observers can figure out with this or that degree of accuracy well before they become obvious to the masses. FSN may be a cruel name somewhat for this phenomenon but can you think of a more precise one?

Second, and more rare kind is what I call GN - Genuine News. This is an event that is either a) a surprise for everyone or b) known to come but with an outcome impossible to predict. This is where Smart Money has little if any advantage. More than that (although this is a somewhat side observation), often Big Money is at disadvantage here because of bigger exposure and lesser mobility in moving in and out... but this is separate topic. Example of the news catching everyone unprepared? Earthquake; fire; sudden death of a key figure... you get the idea. It's just "here is what happened," and no market participant could have taken the right position before the event other than by an accident or an unrelated reason. Thus, news is not discounted by the prior movement and causes genuine market reaction. Example of an event with unknown outcome? Why, EU latest developments... everyone knows something is going to happen, no one knows what. This is where some stay away and some bet on a certain outcome - counting on their opinion being correct, relying on their ability to calculate the most probable course of events or simply gambling.

In the former case (FSN), a trader uses price - information divergence as his most powerful weapon. I have written about this in the past (here and here for instance, not even speaking of here and here), to show how a trader takes position with Smart Money and stops being a part of the Crowd. As difficult as this concept may be for a layperson, for a trader FSN is a normal trading environment, like water for a fish.

GN on the other hand introduces huge uncertainty - instead of moving accordingly to street signs, traders have to wait for new and often temporary signs to be erected. In a news-driven market instead of smooth market flow we have lurching movements in stop-and-go fashion. Time frame shortens to "between the soundbites" - and those often come at unpredictable times.

Thus, in the latter case (GN) - be nimble. Be flexible. Keep your commitment light, do not form an opinion and do not let your Ego lock you in that opinion. Don't be afraid of missing the move by not being in before the move. Remember, newbies chase potential - professionals control risk.

Sunday, September 11, 2011

Trade what you can read

One of the common mistakes among newer traders is the idea that a good chart reader must be able to read ANY chart - that is, be able to create trading scenario, analyze odds and so on. They tend to be surprised by "I have no idea" answer when ask an opinion about certain situation they are interested in. Yet this is my fairly frequent answer - and I don't hesitate to give it when I see nothing recognizable in the chart I am shown.

You see, trading is not about being able to trade each and every movement. Trading is about to be able to pick the right opportunity - right in terms of YOUR trading approach, right in a sense of YOUR ability to read and understand the movement and right in a sense of fitting YOUR risk and objectives profile. What good a perfect breakout chart to you if you are a reversal trader, specializing in trend change setups and having little knowledge of and experience with trend continuation? It's not unlike a hunter who sits patiently in his hide waiting for his prey, waiting for the right moment and acting only when everything is in place for a successful shot.

Then there are situations which present no or almost no opportunity for anyone, whatever their trading style is. If the chart is a mess with no pronounced levels, no volume clues, no clear configurations - it's safe to assume that we are facing an uncertain situation where nervous traders flee the risk, don't commit and engage very carefully if at all. There will be a resolution of this situation, and that's when you will get your signals, setups will shape up and trades will come your way. Until then, feel confident in your lack of confidence - it takes a real trader to say "I don't know." Good teacher teaches humility - and the market is a GREAT teacher. To quote A Taoist Trader:

"The vulgar are clever, self-assured;
I alone, depressed.
Patient as the sea,
Adrift, seemingly aimless.

It’s much more common 
for a really knowledgeable experienced trader to sound reluctant, to be 
unsure of the future developments and admit it openly. Knowing how 
uncertain the market is, he is not so quick to express full confidence; he 
accepts that events may develop in unforeseen way, and such acceptance 
makes him better prepared for an unexpected turn of events. A Taoist 
Trader’s plans and prognosis are usually tentative, with provisions for 
various conditions. They will include many “ifs” and “buts.” He would 
rather plan for multiple scenarios than put his full confidence in a single 
one. "