Why Might a Stock Fall on Good News?

Mar 25, 2008: 11:27 PM CST

You’ve had it happen to you.  You want to buy a stock you’ve been studying for a while, and finally they announce a surprise bit of good news and the price rallies sharply higher and so you jump in, not to be left out.

You have a sudden profit on your hands but suddenly, the stock reverses.  It has retraced back to your entry price.  Wait – actually it has gone beyond your entry price and you’re now sitting on a loss!  You decide that it’s just “market games” and “shaking out weak hands” and so you hold on, knowing that patience is a trading virtue.  Eventually, you’re down further than you expected to be in the stock.

If you were ultra convinced of the upside potential, you may see this as an opportunity to buy more shares at a better price.  Alternatively, you may panic and sell as you continue to watch the price trend further against you.  What happened?!

Recall that the stock market is a rather efficient “discounting”  mechanism that discounts all known (and some unknown) news.  Academicians have even developed the “Efficient Market Hypothesis” which states that stock prices instantly discount all news so that there’s no possible way for an ‘at home’ trader to profit from news releases (or – they say – from trading in general).  While I don’t plan on discussing that concept here, it pays to be aware that some scholars feel that strongly.

Trying to trade news can be an extremely perplexing and frustrating exercise for even the most logical person.  Personally, I have been frustrated endlessly when I would hear a certain piece of market or stock-specific news and then become bewildered when the price traded violently in the opposite direction than the news indicated it should.

“XYZ reports profit 100% greater than last year – stock falls 8%”

“Today’s report showed less supply of oil than expected – oil prices and oil stocks fell hard today”

One reason this occurs is that those “in the know” anticipate conditions before they happen and further anticipate most news reports before they become public.  It starts with the very informed insiders, then trickles out slowly until the ripples get to you when the financial media reports the story.  By that time, those in the know (or those with good guesses about what’s likely to happen) have been accumulating shares quietly.

By the time of the actual news event, they use the interest (and excitement) driven by the public (which are often the last to know) to unload (sell) their shares which have risen in value, and are now spiking greatly due to increased demand.  Once the people who heard the news that day have established their positions (many of which do so very quickly), there are fewer traders to push the market higher and overcome the supply that’s flooding the market.

As a perverse result, the price falls and traders who bought due to good news are confused why they are sitting on a loss.

Recall two key facts:

  1. News does not reach all market participants equally
  2. All participants do not interpret the news the same

As sad as it is, by the time the ‘at-home’ trader has heard the news on TV (unless it’s an “Act of God” or event that was impossible to foresee), it’s probably too late to profit in the direction the news might indicate.

In fact, if news is overwhelmingly good for the day, yet price reverses and closes on its low, then that’s usually a big signal of institutional distribution, and that prices could begin a downswing lower.

It’s much more of an art than a science, but do be careful next time a report comes out and you feel compelled to buy – wait to see how the price (and the market) reacts to the event, rather than acting on the news event itself.


Curve Ball

Mar 25, 2008: 8:21 AM CST

The most recent intraday price swing on the indexes was amazingly smooth and I had to highlight its recent development:

It’s almost as if someone threw a ball into the air, watched it slow down before its ultimate peak, and then is watching it returning back to earth.

Typically you see deeper swings in the market rather than one virtually continuous pathway.

The 15-minute chart makes this a little clearer:

There may be a continuation move up near the 50 period MA support at $124.50, which would set up a most interesting bull flag, but this little swing may just retrace a little larger percentage of the ‘pure swing’ or ’round swing.’

Either way, it is an interesting price development, and one we don’t see often.


Is Google Headed Higher?

Mar 24, 2008: 11:15 PM CST

Google (GOOG) stock has been beaten down by the bears since last November, when the stock made an all-time high near $750. Recently, the stock traded to a recent low of $425, but may the stock be forming a base?

The Daily chart shows a recent positive momentum divergence, following a bear-flag continuation patter which recently achieved (and exceeded) its price projection target. Markets usually attempt counterswings following a successful ‘measured move’ out of the pattern, which could be what we’re having right now.

Price broke strongly above the 20 period moving average, increasing over 6% on Monday, but price has a little further to go to the upside to resolve the divergence properly.

In fact, I would project a potential target resolution near $500, which would be just beneath the falling 50 period moving average. One might even consider this a ‘magnet’ trade that would eliminate a large percentage of ’shorts’ in the stock, while simultaneously drawing in ‘bottom-fishers’ searching for value.

We can’t forget that the trend is still strongly downward sloping, and the moving averages are in the most bearish orientation possible.

Nevertheless, a counterswing up is probably overdue and is most likely occurring at this moment. There could be a $25 upside target to play for if you’re rather aggressive – maybe you’d rather use a few options rather than outright share purchases if you’re feeling like trying to catch a falling knife? Be careful either way.


Link: Umbrellas Cause Rain

Mar 24, 2008: 7:09 PM CST

I had to show you this humerus but thought-provoking post by Adam at Daily Options Report entitled “Stop Trading!  Umbrellas Cause Rain!“.

I’ve always loved how Adam refers to Jim Cramer as “Lord Voldemort,” and this post is no exception.  In this brief analysis which contains plenty of “Cramer Quotes,” Adam discusses how Cramer responded to his horrific call in Bear Stearns and the recent market downturn in general.

“It was the short-sellers on a bear-raid and also the elimination of the up-tick rule!”

I’m with Adam as he writes, “This whole line of thought is annoying. It’s designed to displace blame from some lousy stock pick that would surely have been correct had not those mean old shorts gotten in the way.”

The whole post adds a little levity to your day and gets you seeing the other side of the ‘popular’ financial media that it’s sometimes best as an active trader to avoid.

Check it out and see what you think for yourself!


Monday’s Market Musings

Mar 24, 2008: 6:36 PM CST

Wow, what a day in the financial markets! The NASDAQ (QQQQ ETF) rose 3% today while the other major markets rose 1.5%. Let’s look at a few key charts and see if we can determine what may happen next.

First, the Dow Jones daily:

The market action today was very impressive, and rounds out a recent ‘buy’ swing which was a counter-trend move against the prevailing daily downtrend.

We can’t get too excited until price solidly breaks the 12,800 key resistance level, which is about 250 points away. I suspect that area could be a virtual magnet that will draw price up to test trader/investor conviction at that level. Can demand overcome supply at this level? If so, it would be an important short-term turning point in the market worth further attention.

The market has been helped by rampant negative sentiment (through polls, etc) and also a positive momentum divergence which has resolved itself to the upside with great force. The Fed rate cut definitely helped the market, as did the recent sharp correction in commodity prices.

Also, note that price has breached (crossed above) both its 20 and 50 period daily moving averages. Bulls can’t help but like that fact.

I also can’t help but show the powerful NASDAQ chart and its 3% advance today:

The price action was impressive, but sellers stepped in and supply overtook demand right at the declining 50 period moving average. This still isn’t a ‘higher high’ price swing as of yet. Bulls need to clear this resistance level.

Also, note that the price objective of the symmetrical triangle was been achieved, and so a market reversal was unsurprising. This is a classic example of a symmetrical triangle with a near perfect downside target resolution.

Notice also the major positive momentum divergence which keeps forming on the chart. The resolution is unfolding as the divergence forecast.

Prices may find further resistance from the ‘balance area’ that made up the middle zone of the triangle market consolidation (this was were buyers and sellers came into relative agreement on prices, and they could do it again unless something majorly has changed).

The major hurdles achieved from last week are out of the way, and now it’s time for traders to digest what happened and act accordingly.

Recall that the market already has traveled on a considerable ‘buy swing’ and so a correction or consolidation (preferable to the bulls) at current resistance cannot be unexpected.

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