Become a Successful Trader

February 5, 2013

Macroeconomics: Why the Markets Never Do What We Expect

Have you ever wondered why good economic news is followed by a price decline? Or why a bearish outlook from a fed announcement can send the stock market roaring higher?

There are a couple fundamental reasons for this, but first we must understand the different players that make up the market.

The Market Players:

  • Speculators (Traders) – Those who make carefully calculated bets, addressing the issues of risk versus reward.
  • Gamblers – Those who throw money at the markets on the principle of hope.
  • Hedgers – Farmers & businesses such as Southwest Airlines and those which use commodities and basic materials in their business.
  • Investors – Most likely all of us, this is the largest segment of the market.
  • Locals – Individual pit traders. This group varies slightly from speculators as most of these traders are looking to take the opposite side of the trades put on by brokers.
  • Brokers – Lining the top step of the trading pit, this group places orders which are based off instructions from their investors. These orders are usually taken by phone and then transferred to the brokers by a runner.

The market is a collection of the viewpoints and expectations of all these players. In addition to having different viewpoints, they also have different time horizons.

Long term investors make up the biggest percentage of market holdings. Traders (both intraday and of the short term weekly and monthly time frames) make up a rather small portion of the total market.

That being said, since 2008 with the introduction of high frequency trading (HFT) the volume transacted by traders is much larger than in past years. Certain data has shown as much as 30% of all volume is a result of HFT.

Here’s a video clip from 60-minutes highlighting some of the more detailed aspects of high frequency trading.

Why Market Reactions Are Not Always Logical

Contrary to popular belief there is a large disconnect between the stock market and the economy. The market by nature, prices in future events in anticipation of what will happen.

We’ve all heard the saying buy the rumor, sell the news.

Developments which have very negative implications on the economy and investor sentiment can prompt central bank countermeasures that can lead to a rally. All of these future possibilities get priced into the market at the time of the initial reaction.

Bearish events can trigger future events with bullish consequences, thus after the release of a poor economic number, earnings report, or policy statement that is worse than expected, the market can rally. Potential future actions policy makers may employ such as the fed lowering interest rates, adding liquidity, or easing monetary policy (things we’ve seen in the past few years) have all been the result of this seemingly irrational market behavior.

How to Gauge Fundamentals from Technical Data

When I look for stocks to swing trade there are a couple factors that I consider. Stocks that are making 52 week highs are there for a reason, they have fundamental strength. While short term traders have the capability to push a stock to new highs it’s the role of the investors to keep it there.

At the same token, stocks that are making 52 week lows are down there for a reason. They are fundamentally weak, there are larger fundamental reasons dragging the stock down that far. In this way, we can quickly scan for stocks that are “fundamentally” weak or strong.

*I realize there is much, much more analysis involved in valuating companies with accuracy, the point here is to simplify the process of gauging quickly whether or not a stock is generally sound on fundamental grounds before putting on a position.

How to Improve Your Market Forecasting and Intuition

I highly recommend keeping two trading journals, one for recording your trades and a separate one for recording market observations. In this second journal, make notes on what is happening in the broader market, and then write down what you think will or should happen as a result. Once the outcome is revealed, make notes and compare your initial hypothesis.

This is a great way to build your understanding of macro economics and trading intuition. Always remember to, “expect the unexpected.”

In the markets, anything can happen.

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About Tim Racette
Tim Racette is a day trader of 15+ years in the E-mini futures and swing trader of stocks. Mountain biker, lover of the outdoors, and explorer. Tim is an ASU Sun Devil and a Chicagoland Native now living in sunny Scottsdale, AZ.

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