I believe the majority of market participants agree over longer time horizons fundamentals will influence the price of a stock. But what about in the short or medium term? Should intra-day traders or swing traders be evaluating fundamental news related to the stocks they are trading? Or should they simply focus on price action in relation to news?
I have a lot of thoughts on this topic and rather than spending an entire Saturday trying to sort them out I will give an example of a recent trade I saw a trader place that did not factor in news risk and ended as a large loss (luckily not devastating).
The trade was initially an intra-day long in BUD that turned into an overnight position based on a very strong uptrend on February 1st. For those who haven’t been following BUD recently they had come to an agreement to merge with a large Mexican beverage company. The merger was put in jeopardy on January 31st when the US Justice Department said they would challenge the merger as anti-competitive.
The life blood of our desk is finding stocks that have “catalysts”. The possible scuttling of the merger was a huge catalyst and made BUD In Play. Traders began to trade it. Here are a few things to consider when this type of scenario occurs:
- Is there a risk the stock will be halted by the NYSE because either BUD or the acquiror would make a statement regarding their intentions with respect to continuing to pursue the merger?
- Would an analyst in the sector make a statement regarding the likelihood of the merger being completed?
- What are the possible risk factors in holding a position overnight now that this news has been released?
- How much could the stock gap if new information is released while the market is closed?
- Is there greater risk of a gap higher or lower?
I am confident that most short term traders without legal backgrounds and many years of trading experience have a low probability of answering the above questions with any degree of accuracy. Should those traders avoid trading BUD? Should they consider trading it intraday but not risk an overnight position? I think that unless a trader has more experienced traders to lean on these types of scenarios should be avoided. And certainly an attempt to interpret how this news will impact the stock price should not be attempted.
On February 1st the day after the news was released BUD gapped higher and then trended higher the rest of the day. The market appeared to be shrugging offer the government’s attempt at blocking the deal. Recouping ⅔ if its loss in one day was very bullish price action from the stock. Based simply on price action this was an intraday position worth holding overnight for continuation. A perfect example of what I discussed in the “New Normal” post regarding selective swing trades for 2013.
But markets don’t exist in a vacuum so the question is whether a trader should remove this stock as a possible overnight position because of the increased “headline risk” cited above. In my judgment yes. And this is the feedback I gave regarding the trader who had road a nice intraday uptrend, and was interested in taking advantage of a multi-day follow through trade.
Long story short the trader decided to take the position “home”. Over the weekend a sector expert said the deal would likely not be completed and BUD gapped lower. From a technical perspective the gap lower could have been much worse at 87 was the next important support level and it only gapped down to 89.50. Nevertheless a 3% gap is a large loss to take on a position you were up 1.5%.
This was an unnecessary loss. You will experience a ton of losses on great risk/reward trades so be diligent on making sure you don’t add this type of loss to the mix.
Steven Spencer is the co-founder of SMB Capital and SMB University and has traded professionally for 16 years. His email is [email protected]