Why do prices move?
Does the price follow the news or the new follow the price?
Obviously there’s no hard and fast rule.
It’s impossible to deny there are many occasion when a thing happens and then prices adjust.
If you’re a saddo like me you can while away your downtime reading about the mechanisms behind such moves.
Indeed, I did exactly that on the way home last night when I read this blog post about why asset prices move.
The main takeaway for me came from the idea that there is a distribution of market beliefs.
Hardly an earth-shattering notion in itself. But it is significant, because it implies that people rely on different models, whether explicitly formulated or not, to explain how the world works.
New information will obviously change the output from each market participant’s model.
But new information can have a more dramatic effect. It can cause people to abandon their model and switch to another.
Assume your implicit (or explicit) model leads you to be bullish on an asset while mine leads me to be bearish.
Now some new thing happens that supports your thesis and undermines mine.
You may buy more, while I may well close out short positions and open a new long position – jumping over from bear to bull.
And if I happen to be a big player, that could have a more pronounced effect on the asset’s price than you might reasonably expect that one single piece of news to have.
Then you’ve got the secondary effects.
A piece of bullish news can create the infamous short squeeze. That’s when investors who are short start taking losses and decide (or are forced by their broker) to close out their positions.
They do this by buying back the asset they sold short – adding more buying to the party.
I tentatively proffer that as a (partial) explanation for the pound’s action over the last week-and-a-bit. May announced the election, the pound gains… gains further as shorts close positions… and since then has just been kind of sitting there.
If it manages to establish a convincing uptrend, then you should expect a further knock-on effect – more buying from trend followers.
All of which is a long –winded way of me saying, yes, of course, price often follows news…
It’s often easier to understand the headlines if you think of it the other way round.
It’s like this: if the market goes down, then the financial press need to write negative-sounding stories that “explain” why.
And if it goes up, the news we get is positive.
It was only about three cups of tea ago that the press were telling us solemnly that the Trump reflation trade was done.
Trump’s failure to pass healthcare reform raised doubts about whether he could get tax reform through, we heard.
Fast forward to yesterday and US stock markets closed near all-time highs (or set a new record in the case of the Nasdaq).
The main reasons we’re getting, from what I’ve seen, is the French election rally and, erm, Trump’s tax plans.
So, that’d be an election that hasn’t actually finished yet and a tax reform plan that was supposedly toast a month ago because… well, because the market went lower in the temporal vicinity of that event.
So who’s right? The wires journos of today, who say Trump + tax plan = rally?
Or the men and women of March 2017 in whose hallowed footsteps they follow? The ones who said Trump + healthcare failure = no tax reform?
Search me. There’s a long way to go yet.
Trump wants to cut the corporate tax rate to 15%. Although some reports suggest that’s just his opening gambit.
He also wants to bring in a one-time 10% tax on overseas earnings, according to officials. That raises the prospect of a mas repatriation of the trillions – with a T – that giant US companies have parked outside America.
Throw in the fact that the destabilising Border Adjustment Tax is dead (though some reports suggest it’s just sleeping for now) and there’s plenty there to justify a rally.
And, quite likely, this week’s market moves have unfolded as advertised.
Encouraging, status quo-supporting news from France and then the Trump Administration probably did encourage stock buying.
Not so much because investors bought into the story, more than they felt the story would justify others buying so they should be long amid the bullishness.
But we can never be totally sure. We don’t have the counterfactual. Had the market gone down, we can guarantee “reasons” would have been found to “explain” it.
Relief, euphoria and negativity are always swirling around somewhere, ready to pipe into a hot-off-the-press analysis that’s hugging battered cod come tea time.
The point is, following the financial news isn’t as useful as you might reasonably expect (though as a DR reader you’ve already got yourself one step ahead of that. No one can accuse me of being bang-up-to-date or right-on-the-pulse).
So how do you get an edge?
Should you just give up?
Our publisher Darren and I had lunch yesterday with one of our newer contributors, wealth manager Jonathan Davis.
A recurring topic as we chatted was the importance of trends. And of paying attention to trends. And of allowing the market to tell you what to do, rather than seek to impose ideas on the market.
In other words, tune out 90% of the news, keep an eye on the price, and wait for a signal that tells you what’s what.
Then you can start digging deeper to see if the asset that’s caught your interest is somewhere you want to put your money (and do dig deep enough to get below the shallowsphere of financial press analysis).
Want a tool that will help you do that?