Today’s Trading Lesson From TradingMarkets

Brice

How To Make Money
From The News

By Daniel Beighley

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:

1. 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.

    

2. 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.

    

3. 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)
— 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)
— 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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