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Trading on News-Driven Events
There is never a shortage of news to trade with earnings,
warnings, partnerships, takeovers, patents, government approvals
and product releases jamming the wires on a daily basis.
But there is a smart way to trade the news.
Rule No. 1: Trade In the Right Direction
Perhaps the first and most important rule about trading news
events is to be certain that you are interpreting the news the
same way that the market is seeing it. Some news events that you
think will be positive for a stock might not be positive at all.
What's worse, some can seem positive, and actually be negative,
and vice versa.
Before you trade Apple Computer (AAPL) short because of a
battery recall, you need to know what you're getting into. Had
the recall news been anticipated? Will the company's earnings be
materially impacted? Will the Street see the recall as a major
negative event? How has Apple's (AAPL) stock been trading in the
hours leading up to the recall announcement? Is there a
technical setup that makes a trade practical?
In the case of just such a recall in August, a short in Apple
was a lackluster call. The stock dipped lower initially, but
came roaring back intraday, as the news was somewhat
anticipated, earnings were not impacted, analysts saw it as no
big deal, and the stock had already fallen ahead of the
announcement. The best setup after the news was arguably on the
long side, after the initial selloff.
Rule No. 2: Know Your Stock!
When Microsoft (MSFT) announces a large share buyback, and the
stock has already gapped up at the open, you should be asking the
following questions: Have the after-hours traders the previous
night and the pre-market traders this morning already run the
stock too far? Was the buyback mostly anticipated? Have the
brokerages already sounded off with positive notes? What other
positives could be in store in the near-term to continue pushing
the stock higher? What does the chart look like? And most
importantly, is there a risk-reward ratio that makes this trade
worthwhile?
Rule No. 3: Wait, But Not Too Long
Sometimes it is beneficial to wait a bit to "confirm" that the
Street is interpreting news the same way that you are.
But you can't wait so long as to put yourself in the position of
"chasing" a stock. To prevent chasing, you should have a
risk/reward ratio in mind when you place every news trade.
Generally, that should be 2 to 3x upside to 1x downside.
Rule No. 4: Limit Losses With the Use of Protective Stops
So let's say you want to enter HITT long at $44, and you are
willing to risk $0.50 on the daytrade, with a stop at $43.50.
You need to determine that the news is positive enough, that you
are in the name early enough, and that there is no near-term
technical resistance that would prevent you from seeing the
stock go at least $45 or the trade is likely not worth it.
Trading news can be akin to hitting a baseball. You'll strike
out and miss many trades altogether. And that's OK. If something
material happens and you are not in position to get in early,
it's often best to let the trade go. Don't chase! Watch
resistance levels, and keep an eye out for a low volume pullback
where you may be able to purchase the shares at a later time,
often at or near the same level when the news hit.
Additional Tips on How to Avoid Chasing Stocks:
1. Think twice about entering most stocks that have
already moved in excess of 5% after a positive news
announcement. The news needs to be extremely good and affect
several quarters going forward to make a long position at that
point worthwhile.
2. Consider using limit orders, to avoid paying too much
for momentum stocks, vs. jumping in with a market order
following a press release. You should be especially be wary of
using market orders for low-float and low-volume stocks. While
you may not get filled with a limit order, that might be
preferable to getting filled at a price peak.
3. Less experienced traders might want to avoid trading
very volatile, low-float or low-volume stocks on news. The
stocks that are known for making 25%-plus moves in a single
session can also turn quickly... often at unpredictable points.
Such stocks are also names that can be easily manipulated. We
tend to post such stocks under the Speculator's Radar heading.
4. Keep in mind that one of the best ways to avoid
chasing is to look for a sympathy play off the stock that's
moving on news. If Texas Instruments (TXN) just reported strong
earnings, based on demand for analog and mixed-signal chips, one
trade could be Eagle Test (EGLT), which makes chip-testing
equipment, since TXN accounts for a third of EGLT's revenue.
Also look at smaller rivals to Texas Instruments (TXN), such as
Freescale Semi (FSL).
Take Profit
Last but not least, remember that arguably the most difficult
part of trading news (or trading at all, for that matter) is
knowing when to take profit. Use a strategy that works for you,
but don't sacrifice profit on good entries because of greed.
One that we try to employ with our Emerging 50 list is to take a
"first profit" early on about half the position on all
successful ideas. We then adjust the stop to the breakeven
point, and allow the rest of the position to trend to an attainable
target.
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