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Week 17: Good news/bad price
Counterintuitive price action can send an important message
Welcome back to Fifty Trades in Fifty Weeks!
This is Week 17: Good news/bad price.
50in50 uses the case study method to go through one real-time trade in detail, about once per week. This Substack is targeted at traders with 0 to 5 years of experience, but I hope that pros will find it valuable too. For a full description of what this is (and who I am), see here.
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Update on previous trades
There are four active trades right now and they are all hovering just above or below break even. Long BTC, long ARKK, --CVNA/++RBLX (RV trade), and short ETHBTC. Nothing significant to report, really. I will update in more detail when larger moves happen and larger P&L is generated!
Good news/bad price
Price action is mostly meaningless. Markets go up, down, and sideways for all sorts of reasons. The numbers on the screen jiggle and flicker in constant motion, but there is barely any signal in all that noise. Erratic and semi-random flows create bid/offer bounce and the illusion of meaningful market movement as randomness dominates.
Traders often come away from reading a book like “Reminiscences of a Stock Operator” with a feeling like they, too, might learn to get a visceral sense of where a market is headed just by watching it go up and down for a while. But that is rarely the case. Reading the tape is barely a thing.
Still, while I believe price action is mostly meaningless, it’s not completely meaningless. The way price reacts to news can sometimes contain information. Every time news comes out or a market correlated to yours goes up or down, you have an expectation of what will happen in your market. Good traders have a good sense of the range of possible catalysts and news items that might come out, and they have a range of expectations for how those catalysts will impact price.
For example, traders in these markets should know the answers to these questions right now:
If Boris Johnson loses the vote of confidence… Is that good or bad for GBPUSD?
If the SEC announces that ETH fails the Howey Test and is ruled to be a security, how will various altcoins trade? How far will ETH drop? What will BTC do?
If the ECB meeting this week signals a 25 basis point hike in July, not 50… What will German bunds do?
When price does something other than what you thought it would… That’s a potential signal.
Trade the News
The price of the security or market you trade is an equilibrium determined by the sum total of all the available information in the world. When new information arrives, the market will move to reflect that new information, but the market won’t find a new equilibrium instantaneously. Different market participants will have different opinions of what the new info means, and they will have different positions, incentives, and risk tolerance.
Trading the news can be a major edge if you know your market extremely well and have an expert understanding of how new information matters (or doesn’t matter). Important information will create opportunities to jump on a move quickly, before it’s fully played out. Many of the successful traders in Jack Schwager’s latest book “Unknown Market Wizards” trade the news prolifically.
I will write a piece on how to trade the news at some point in this series, but today I want to discuss a specific setup that sometimes unfolds after news comes out. It is a setup that can be extremely useful and will help you play both better offense and better defense.
Good news/bad price
In brief, good news/bad price is a scenario where a market doesn’t react logically to a clear piece of news. For example, great news comes out in your favorite stock, and the stock closes lower on the day. Or bad news comes out on the economy, and yields go up. I called this note “Good news/bad price”, but bad news/good price is obviously the same setup in reverse. If bad news comes out, and the price goes up, that’s the same concept as good news/bad price, just flipped.
To be clear, the counterintuitive reaction in the market does not have to be instantaneous. For example, an unexpected bullish headline hits and your favorite stock rallies 4%. But then momentum quickly starts to fade. Now the stock is only up 3%. Now just 1.5%. Now flat on the day. And… It’s gone. That’s good news/bad price.
What are we to make of seemingly nonsensical days when there is good news and the price goes down?
Before we answer that, you first need to be close to 100% sure that you are interpreting the news correctly. Only unexpected news moves markets. If AMZN is expected to report record earnings, and they report record earnings… That’s not news and it’s not bullish. It’s neutral. The record earnings should already be factored into the price.
If everyone expects the central bank to hike rates by 0.25% and they hike rates by 0.25%, the market shouldn’t move much when the hike is announced. On the other hand, if nobody expects the central bank to hike rates and they hike rates, you can expect a massive market reaction.
This concept is known as news being “priced in.”
To trade good news/bad price, you first need to rule out a) you misinterpreted the news and b) the news was already priced in.
CRITICAL CONCEPT: Understand What Is Priced In
Before you can trade or interpret the market’s reaction to a surprise headline, economic data, central bank meetings, or any other news event, you need to understand what is priced in. This is an absolutely critical concept for anyone who trades any financial market. If you trade or ever plan to trade any security in any market, you need to fully and completely get the concept of “Priced In”. If you read this section and still don’t really get it, ask someone to explain it more fully. Every trader must be completely comfortable with the concept of what is priced in to a market.
Financial market prices are generally set by the sum total of all the buying and selling done by every human and computer market participant in a giant, unending series of auctions. Different buyers and sellers will decide to buy or sell depending on the price, and as prices move different actors with different time frames will enter or exit the market.
Decisions to buy and sell are generally driven by the market’s assessment of fair value for the security and this assessment should (in theory) be composed of all the available information that relates to that security. As new information comes in, prices move in real-time and should quickly incorporate and reflect that new info. Let’s look at an example.
Currencies are highly sensitive to interest rate movements. Therefore, it makes sense that currencies should move when central banks adjust their primary interest rate. Here is an example of how a currency can move when a central bank unexpectedly changes interest rates.
Hourly USDCAD around a surprise interest rate cut from the Bank of Canada, January 2015
When something unexpected like this happens, it is not priced in. This move higher in the USD vs. CAD is what you would anticipate because an unexpected rate cut by the Bank of Canada makes holding Canadian dollars less attractive given the lower yield. The market sells CAD and buys USD, driving USDCAD higher because the cut was a surprise, and NOT PRICED IN.
In contrast, let’s say six months ago, rumors start that Apple’s self-driving car is coming soon, probably in the next six months. Apple stock rallied 5% on those rumors. Three months ago, images of the car were leaked online, confirming the rumors. Apple stock rallied another 15%. Two weeks ago, five Apple insiders confirmed to the WSJ that Apple’s self-driving car announcement was imminent. Apple stock rallied another 12%!
Today, Apple announces yes, they will be releasing a self-driving car tomorrow. Do you buy Apple stock? … Probably not! The news of the self-driving car is known and is already reflected in the higher price of Apple stock. In other words: It’s priced in. If anything, Apple stock is more likely to sell off today in a pattern known as “Buy the rumor, sell the fact.” I will discuss “buy the rumor/sell the fact” in a future 50in50; so don’t worry about that for now.
With earnings reports and economic releases, you can nail down almost exactly what is priced in because there are surveys that establish the expectation. With other news events and headlines, it helps to be expert in your product and talk to as many people as possible. If you talk to dozens of traders who trade your asset class, you’re going to have a pretty good intuitive idea of what’s priced in for almost any scenario. Reading and following experts on Twitter also helps you identify what’s priced in.
OK, so you understand the concept of what is priced in.
You are trading your favorite fake meat stock, BYND. The stock is trading at $25. Good news comes out — Outback Steakhouse will soon put the “Beyond Filet Mignon” on the menu at every one of its 700 US locations. Crikey! You are certain this news is unexpected. It is not priced in. BYND gaps up 9% in an instant, but then it immediately turns aggressively lower. By the end of the day, the stock is DOWN 1.5%
What the actual???
That price action is extremely important. When a market cannot rally on good news or it cannot sell off on bad news, it is revealing information. What could that information be?
Positioning is heavily one-sided. If everyone is already max long BYND and they come out with a huge positive announcement… There is nobody left to buy. In that scenario, the price might rally a bit on the kneejerk, but then sellers will come in one by one to use the headline liquidity as an exit.
A large seller is lurking and wants to take advantage of any surges in liquidity. Let’s say I’m a Boston asset manager and I’m long 4,000,000 shares of BYND. I decided today that I want to get out of all my BYND because I believe lab-grown meat is going to take over from plant-based meat. I’m talking tactics with the execution desk when DING DING DING a bullish headline comes out. Sure, it’s good news, but it doesn’t alter my longer-term thesis. The stock rips to $27 on high volume. I tell the execution trader to run a 60-minute TWAP with a $25 limit for 4 million shares. The headline buyers run into my supply and the stock slowly rolls over. Soon, it’s back below $25, and I managed to slide out almost 2 million shares. Nice. By the end of the day, the longs are stopping out at $24.
There is event risk coming up. If US economic data comes out super strong, people will generally buy the USD and sell bonds. But let’s say ISM comes in three standard deviations stronger than expected, but there is a US Presidential election tomorrow. Is the market going to pile into the USD, given there is a more important event in less than 24 hours? Probably not. You will very often see weird price action into events as the market is more concerned about reducing whatever risk it has on, than trading in the direction of the logical macro narrative.
There are other reasons a market might not rally on good news, but the main point is to identify those moments and understand what they mean. Good news/bad price is bearish. The market should have rallied, and it didn’t. That is going to make bulls nervous and give shorts confidence. Let’s look at a recent example.
Last week’s jobs report
Nonfarm payrolls (the US jobs market report) came out Friday, June 3 and the market reaction on the release was just about unanimous. It went something like this: Strong headline jobs, and lower wages = goldilocks. A goldilocks number is one that signals the economy is not too hot and not too cold and strong jobs growth with lower earnings growth is just that. I am in a ton of Bloomberg chats with various hedge funds and banks and every single one read the report as Goldilocks and good for stocks.
Here is what happened
5-minute chart of S&P futures after nonfarm payrolls
Stocks went up for about four minutes, then down for the remainder of the day.
Let’s look at an even more dramatic version from last week, this time bad news/good price. Before I show the chart, let me give a bit of background. The market is excited about the prospect that the Swiss National Bank (SNB) might hike rates soon. All the market was waiting for was one more CPI number to confirm the thesis.
If you think the SNB is ready to hike rates, the trade is to sell EURCHF (that is sell euros, buy swiss francs). Swiss CPI was coming out, and if it was strong, it was the best excuse in the world to sell EURCHF. CPI came out, and it was a monster. One of the biggest topside misses ever in the history of the series. Here is what EURCHF did:
EURCHF 1-minute chart around CPI
Whoops. EURCHF dropped a full day’s range in one minute, then spent the rest of the day going up, up, and away.
How to trade bad news/good price
How do you know when to pull the trigger on a bad news/good price setup? The simple starting point is you always identify the level of your market just before a major headline or news item. This level is called the NewsPivot. In that EURCHF example, the market was trading 1.0270 before the CPI data came out so that’s your NewsPivot.
If news like this comes out that is massively bearish EURCHF, the pair should never go back above the NewsPivot. If it breaches the NewsPivot, that’s bad news/good price. If you are short, get out. If you were bullish for some other reason, get long!
Here is what EURCHF did after:
EURCHF 1-minute chart around and after CPI
And for the record, this is not hindsight. I wrote about this bad news/good price setup in my global macro daily (am/FX) when EURCHF was still 1.0670, after the CPI release. Some of the clients I cover exited their shorts at that point because the setup was clearly bullish EURCHF. You can read the full note that I wrote that morning right here.
This is probably a good place for a quick mention of the daily global macro note, am/FX. I have been writing that since 2004. If you want to learn more about trading and see my FX and macro ideas in real time, you can sign up here. My weekly crypto note is available there too.
I do not trade the good news/bad price setup systematically. I watch how markets trade around each NewsPivot and monitor closely for weird reactions. When I see one, I use it as a trigger to either initiate a trade I was interested in anyway, or to get out of existing risk.
Unambiguous news should trigger unambiguous directional moves in the market. If it doesn’t, something or someone else is in control.
Effective on many fractals
Price reaction to news isn’t just an intraday trading thing. Quite often, you will see a major turn in a market after it fails to respond logically to news. A counterintuitive and important concept that every trader needs to remember is this:
Major lows come on bad news. Major highs come on good news. It’s very rare that a market is at the lows, good news comes out, and it rallies and starts a new up trend. Very often, it’s the opposite. Bad news triggers a push to new lows and that push cannot sustain, signaling that sellers have run out of ammo. That’s the rebar on which bottoms are built.
An example of this that I will never forget is the day that Osama bin Laden was killed. At the time, the killing of Bin Laden was viewed as super bullish news as it eliminated the head of one of the great threats to US national security. Stocks initially blasted higher on the news, but then the market slowly drifted lower for the rest of the day. Here is the chart:
The day Osama bin Laden was killed marked a medium-term high in US stocks
I remember at the end of that day, many traders turned super bearish stocks because it was stunning to see the SPX close in the red on such apparently important news. It worked! Good news/bad price.
The recent price action in gold after the Russian SWIFT announcement is another example. The weaponization of the USD was seen as great news for gold yet gold went up for a few days and is now much lower.
A possible good news/bad price setup in LLY
Eli Lilly (NYSE: LLY) closed at 301.60 yesterday and rallied to 315.13 today on promising news about a weight-loss drug. Let’s say I was bearish LLY for whatever reason and I see the chart looks like this:
LLY stock for the past 10 days
The reason I said “Let’s say I was bearish LLY for whatever reason…” is that I don’t do trades purely on a tech setup like this. I use these types of tech setups (volume spike at price extreme, slingshot reversal, etc.) to determine tactics, not strategy.
So the good news came out at a price of 301.60. Below there, the price action is not good. Given we have a low of 298.20 on June 2, I will leave a stop entry to go short LLY at 297.99. If done, stop loss at 306.25. That stop loss is above the old 298.20/305.85 equilibrium zone that dominated in the two days before the positive news came out. Zooming out a bit, the chart has mostly been in a 280/315 range since mid-March so I put the take profit at 283.10. Risking 8 to make 15.
If the stop entry order is not executed by the close this Friday, June 10, I will cancel it and forget about the idea. Good news/bad price setups don’t last very long because the more time that passes after a new headline, the less relevant it is to the price action or psychology of the market. That is, super quick rejections of news are more valid than rejections that take a long time.
When unambiguous good news about a company comes out, the stock should go up and stay up. If it doesn’t, there is often some signal and forecasting value in the price action. Any time price doesn’t do what you think it should be doing:
First, question your underlying assumptions. Do you fully grok what is driving the stock and what news is important? Is the market doing something truly weird, or is it just that you don’t understand what’s going on?
Second, pay attention! Good news/bad price is often an early warning signal telling you to be careful. It can be a sign of large positions in the market, large flows in the market, and counterintuitive supply/demand imbalances that run counter to the primary newsflow.
Use good news/bad price to get into trades you like, and out of trades you don’t. Once a market crosses back through a NewsPivot after a major event, headline, or announcement, get ready for a quick, painful, and aggressive move the other way.
That's it for today. Thanks for reading!
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DISCLAIMER: Nothing in “50 Trades in 50 Weeks” is investment advice. Do your own research and consult your personal financial advisor. I’m putting out free thoughts for people who want to learn. This is an educational Substack. Trade your own view!