How To Make Money From The News
News Reversals is a trading strategy
developed by Larry Connors and first published in Street
Smarts in 1995.
We’ve all see the effects news can have
on the market and individual stocks. Many of us have had the
unfortunate experience of being on the wrong side of the news. News
Reversals is a strategy designed to always put yourself on the right
side of the news.
With the News Reversals strategy, we’re
looking for key news on stocks occurring outside of the normal market
hours, then watching for the stocks to gap above or below the prior
day’s trading range. A stock that gaps, then trades back into the
prior day’s range will trigger a News Reversal. Once triggered, the
trader has profitable edge working for him or her.
So why does the strategy
work?
A stock that rejects news is speaking
very clearly with the message: “I don’t care about this
news.” By stepping in right when the stock begins to trade into
the prior day’s range, we’re taking advantage of a panic that sets in
as the stock rejects the news.
This is what we call trading “counterintuitively.”
Logic tells you that a positive news event should translate into a
positive reaction for the stock, though experienced traders know
better. Stocks will do whatever they want to, and only those who trade
with the “herd mentality” will buy into such events.
The rules for the strategy
are as follows:
- Traders should wait for an extremely
bullish or bearish event to occur after the market has closed. Equity
traders should be looking at earnings reports, takeover rumors,
brokerage house recommendations, and so forth. For futures traders,
this can be a crop report, livestock report, economic report, weather
report, etc. - The market must gap above or below the
previous day’s high. On openings that gap lower, place a buy stop one
tick above the previous day’s low. For openings that gap higher, place
a sell stop one tick below the previous day’s high. - After you are filled, stops should be
placed at the lesser of either the morning’s opening price or 1 point.
As price moves in your favor, stops should be adjusted to lock in
profits.
Here are some examples:
Proctor & Gamble (PG) —
On Dec. 12, 2002, the company raised its earnings guidance for the
second quarter.
Here PG gapped up on the news,
attempted to move higher, but couldn’t hold the price level and
quickly sold off. As soon as the stock dropped below its previous
day’s high of 87.90, it triggered a News Reversal. We go short at
87.89. The stock had a maximum move of 1.64.
Of course, we don’t always get the
perfect fill due to lack of an up-tick, price gap, etc., so it’s best
not to chase these any more than 0.10 – 0.15 below the trigger price.
Also, we can never expect to capture all of the move, so we’re going
to use a trailing stop in an attempt to optimize our profit potential.
We see News Reversals nearly every day, so it’s best to make a habit
of taking the money while it’s there. Execute like a machine.
Biogen (BGEN) — On Jan. 6,
2003, the company was downgraded by Salomon Smith Barney to “underperform”
from “in-line.”
Here with BGEN the stock gapped down on
the downgrade, then triggered a News Reversal one hour into the
session at 41.09. The stock gave us a maximum move of 0.97 for the
day. The price action here gave us a nice steady climb higher, as it
closed well in our favor at the end of the day.
The decision to hold a position
overnight is up to the individual trader. A stock that closes at the
top of its daily range is more likely to continue higher the next day,
although as can be seen in the example above, this is not always the
case. Playing these as pure daytrades is the more risk-averse
strategy. No matter what, always lock in a portion of your profits.
Hewlett Packard
(
HPQ |
Quote |
Chart |
News |
PowerRating)
— On Dec. 16, 2002, the stock was added to Merrill Lynch’s Focus One
List.
Like every other strategy with an edge,
there will be times when it does not work. In this example of Hewlett
Packard, the stock gaps higher on the news, triggers a
“sell” at 18.78, then moves 0.17 in our favor before
reversing back to its open price of 18.91 for a loss of 0.13.
With the stop loss we want to take the
lesser of either the opening price or 1 point. There is no arguing
with this rule. The stop loss is your most powerful weapon when it
comes to succeeding as a trader. Use it properly and without
hesitation.
Symantec Corp.
(
SYMC |
Quote |
Chart |
News |
PowerRating) — On
Jan. 16, 2003, the company beat its third-quarter earnings
expectations by $0.08 with profits of $0.47 per share.
At times, a trade will trigger, then
move sideways for a good part of the day. This can be a frustrating
situation which calls for patience. In the above example, SYMC gapped
higher after easily beating its earnings expectations. The stock
triggered a “sell” at 47.54. In the first 10 minutes, the
stock moves 0.43 in our favor, then quickly reverses and trades
sideways for over an hour in “unprofitable” territory.
Eventually the stock gives us another move down for a maximum
potential gain of 0.53.
Managing a trade after it triggers can
no doubt be a difficult task, but keep the perspective that a
triggered trade has an edge on the market, and the goal is to be
profitable. Using 2-for-1 money management is a great way to capture
gains while remaining exposed to further profits. With SYMC above, it
would have been smart to take some off after 0.30 – 0.50, then set a
stop loss for the second half of the position at breakeven. Worst-case
scenario, you take home a small profit. You can’t go broke taking
profits.
How do I find News
Reversals?
By giving the news a good read every
morning, you will find ideal candidates to put on your “hit
list.” TM also has a News
Reversal Service, run by me, that selects candidates every
morning. On average we see 1 – 3 stocks trigger a day. If the stock
doesn’t gap, it’s not a setup.
To narrow things down, it is best that
the stock be over $15 in price and trade at least 300,000 shares for
average daily volume. The higher the price and volume, the better. We
look at these trades in terms of point moves, not percentages. Also,
stocks that gap over 5% will have less of a chance to trigger.
To sum things up:
News Reversals offer a clear edge for
succeeding in the markets. Some people may be uncomfortable with the
idea of trading against the common logic of a news event, but
remember, it’s the “herd” that most often gets exploited in
the market.
If you have any questions, please don’t
hesitate to ask.
danielb@tradingmarkets.com
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