Most rookie traders and investors use the news improperly. They try to place short term trades based on the news. For example, they’ll try to short the stock market if they expect the monthly Employment Report to miss expectations. Here are the improper and proper ways to use the news for trading.
Don’t trade the news
People who “trade the news” try to guess the news and then predict the market’s reaction to the news.
You must guess the news before you can “trade the news”. Here’s the simple reality: nobody can consistently and accurately guess the news.
For example, the month-to-month fluctuations in economic data is mostly random. Trying to guess each month’s economic data is a 50-50 bet. That’s why good economists focus on predicting the overall trend in economic data. It’s impossible to know if the next month’s economic data will be positive or negative, but it is possible to predict if the economy will improve or deteriorate over the next few months.
There are multiple pieces of news at any given moment in time. Not all of this news will be bullish for the market and not all of this news will be bearish for the market. Some of this news will conflict with each other. It’s impossible to know which piece of individual news is the most important one at any given point in time.
Even if you could guess the news ahead of time, it’s impossible to consistently and accurately predict the market’s reaction to a piece of news. Markets can interpret the news either way in the short term. The market might fall on news that you thought was “bullish”. The market might rise on news that you thought was “bearish”. The “sell the news” dogma is only accurate 50% of the time (i.e. it’s useless). It’s only a “sell the news” event AFTER the market has already fallen. Hindsight is 20-20.
*”Sell the news” means that the market falls on bullish news because the bullish news is supposedly already “priced in”.
E.g. If the stock market rises on upbeat economic data, the media will say “the stock market went up because a strong economy is bullish for stocks”. If the stock market falls on upbeat economic data, the media will say “the stock market went down because a strong economy means that the Fed will tighten monetary policy.” The media makes up these BS headlines just to find an excuse for every short term market movement. The reality is that most short term market movements on news are random.
Some traders try to attach a price target for each piece of news. For example, they’ll say “I expect the S&P to fall 1% because the CPI report will beat expectations”. This is silly. It’s impossible to consistently and accurately predict the market’s reaction to each piece of news. It’s even more difficult to predict the MAGNITUDE of the market’s reaction. Anyone who tries to predict the market’s EXACT reaction to each piece of news is trying to play God.
It’s impossible to trade the news after the news comes out. By then it will be too late. The market often whipsaws back and forth after a piece of news comes out.
For example, let’s assume that the Jobs Report is weak. The stock market tanks 1% in the first few minutes after this news comes out. If you short the stock market after it falls 1%, the market might “buy the dip”, reverse upwards, and turn your short position into a loss.
Chasing the news is especially dangerous in a bear market. News tends to fly all over the place in a bear market or crisis situation. One second there will be a bullish piece of news and the next second there will be a bearish piece of news. Chasing the news will result in losses on both sides of the market.
You also can’t guess the market’s subsequent reaction to a piece of news. E.g. Sometimes the market will initially rise on a “bullish” piece of news and then fade those gains over the next few days. Sometimes the market will initially fall on a bearish piece of news and then surge a few hours/days later.
How to properly use the news for trading
Traders shouldn’t place their bets by guessing whether a piece of news is bullish or bearish for the market.
Instead, traders should use the constant stream of news to slowly develop their medium-long term market outlook. Each piece of news will either strengthen your medium-long term case or weaken your medium-long term case. If the overall news (not every single piece of news) supports your medium-long term case, then you should continue to believe in your case. If the overall news is starting to go against your medium-long term case, then you should reconsider your case.