Fading the Fluff: The Art of Trading Against News-Driven Moves
Like most people who follow financial markets, I am a news junkie. Keeping up with events, both domestic and international, is essential if you want to form a balanced, long-term view of any market.
As somebody with a trading background, though, I am suspicious of short-term reactions to news items. I spent this last weekend at a conference where stock trader Michael Goode explained his technique for what I will call “Fading the Fluff.”
The basic assumption is that most news that comes out is nothing of the sort; it is fluff with little or no substance yet related stocks still react, at least initially. That move gives traders an opportunity to fade (or trade in the opposite direction of) that false move.
Many of the examples that Michael used in his presentation were in the biotech industry, and that is a particularly fertile field for this kind of trade. It seems that every time a small company announces something, as long as that thing isn’t something hugely negative, such as bad trial results or an approval setback of another kind for a drug, the stock reacts positively. That isn’t the only place it happens, though. There is also a tendency to buy the fluff in more liquid and even broader markets.
The last 24 hours have produced a couple of classic examples. In fact, the entire stock market did it yesterday. All of the major indices traded much higher after three separate Fed people spoke. Their words were interpreted as meaning that two were in favor of caution when it comes to the timing of the next hike, while one was more hawkish.
I was travelling back from the conference yesterday, so wasn’t watching the market, but when I got off of my delayed flight and saw that the Dow had popped over 200 points on that, I was stunned.
I mean. Look at what that actually means. First, from a broad perspective, we knew before and still know now that the Fred intends to raise rates at some point in the not too distant future; all three speakers confirmed that. Where they differed was in the desirability of an immediate 25 basis point (one quarter of a percent) move.
You could make a case that neither that move nor the timing of it is particularly significant, but let’s assume for argument’s sake that they are. In that case you would think from the reaction yesterday that we had discovered something new that changed a lot of minds, but that really wasn’t so. We have known for a long time that the Fed is divided, with some favoring a quick hike and some still wishing to hold off.
Yesterday changed nothing about that; what was released was not news.
What it seems happened is that traders read into the three speeches what they wanted to hear. The stock market is still awash with cash, so it has a natural upward bias, and that came back yesterday after a bit of a wobble on Friday. The problem with this is that Friday’s wobble was based on a realistic assessment of the situation while yesterday’s rally was based on fluff. Early indications this morning are that some of those gains will be given back today.
The other market that demonstrated the advantages of a “fade the fluff” strategy this morning is crude oil. After climbing yesterday, WTI futures dropped overnight on a report from the EIA that indicated that the market was oversupplied and would likely stay that way for some time. That is undoubtedly true, but given that we have known that for, at the very least several months, any market reaction to it was, by nature, overdone.
In this case the “news” was not really fluff, I guess. It was simply a restatement of something that has been obvious to anyone who even casually follows the energy markets for some time. It was non-news, in fact if “olds” were a word, that is what this would be, so watching WTI come off over a dollar based on that gem should have been a surprise. It really wasn’t as the oil market has had a marked tendency to do this lately. Just look at the strong rally every time somebody from OPEC, the broken oil cartel, states the obvious: that there is a chance that, at some point in the future, the OPEC nations will agree to a production cut. Well, of course there is a chance.
The essential truth here is that the market, and individual traders and investors as well, often fall victim to their own addiction to news. Reacting quickly to some things, such as actual data and real events, is an essential part of trading, but that can lead to seeing every release as hugely significant and reacting before analyzing. Machines can be guilty of this too, these moves are often exaggerated by automated traders reacting to key words in the same press release or story.
In reality, of course, not every release is actually news, and that frequently sets up an opportunity to fade the fluff.