Reacting to Events

The market reacts to events.  Should you?

The assassination of former Prime Minister, Benazir Bhutto, is a loss for Pakistan and a blow to the transition to democracy taking place there.  While investors and fund managers may have sympathy for those with personal stakes in these events, these thoughts are quickly crowded out.  As we have noted, most turn almost immediately to the broader implications and the impact on stocks.

How Markets React

There is a saying that "the market hates uncertainty."  At "A Dash" we believe that treating the collection of market participants as a unitary actor is rarely useful, but there are some exceptions.  Faced with a surprise event, the initial reaction of each decision maker is usually caution.  Few are poised to buy any "dip" without knowing and understanding the "news."  The collection of these individual behaviors gives rise to the market reaction.

Since there are always sellers, news surprises cause potential buyers to pull their bids, "keeping the wallet on the hip" as Art Cashin puts it.  This happens even in cases where there is no specific reason for a negative reaction — a plane crash, an explosion, a space travel disaster.  Surprises rarely represent good news and might be evidence of something much more serious.  Buyers step back.

Today’s Events

Futures markets moved lower immediately as the news hit the wires.  Gold traded higher, as did oil.  Increased world tension and uncertainty is bullish for these commodities and bearish for stocks.  As the market day proceeded, various experts discussed the implications for elections in Pakistan, increases in terrorism, and other global ripple effects.  Tomorrow’s newspapers will attribute today’s market decline partly to international tension and partly to economic data.

Would the economic data have had such an effect in a different environment?  There is no way to know, it seems unlikely.  The specific news (weak durable goods, slightly higher jobless claims, and yet another scary estimate of mortgage write-downs) did not have much impact of futures trading, as noted by  Sometimes it all comes together on a light trading day where many are taking the week off.  As usual, bears will make this seem like a meaningful day and journalists will reach for explanations.

How should the investor react?

How to React

In general, news should facilitate one’s plans, not derail them.  Investors looking for an entry point now have a better one.  If you needed to sell a position, nothing has changed;  you still need to sell.  The system trader may occasionally deviate from the model, as we sometimes do with our methods, but the exceptions should be based strictly on events that change the underlying analysis.

Reacting with discipline and calm in the face of apparently negative news is one of the most difficult trading skills to learn.

Weekly Update

Each week we accompany the insight about trading with an illustrative peek at how we implement the advice in one of our programs.  It has been a choppy period for many ETF sectors, as the trade history will show.  Despite this, the TCA-ETF model remains bullish on most sectors, as well as on the overall market.  While we are not making specific recommendations, we hope that some ETF investors may find it useful to compare our rankings with their own choices.

Also noteworthy is the 2008 ETF forecast from Tom Lydon.  We hope he is right on some of these calls, especially the expansion of liquidity and choices.  That helps everyone!


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One comment

  • illustrative December 31, 2007  

    Reacting to Events

    Bookmarked your post over at Blog!