In this series, we'll take a look at the differences between retail and professional trading. In each post, we'll focus on one aspect where we see a major difference between the two groups. In this first one, we'll look at the scope of decisions made to enter trades.
Obviously, there's no 'one size fits all' trader on either the professional or retail side. I've met professional traders that follow the sloth-like queue on ultra-liquid markets. I know retail traders that thrive on the super-fast DAX and others that run from it in fear (and rightfully so).
There's one fairly big difference that is quite endemic. On the professional side, it's generally accepted that there are many things that can move the markets. At the lowest levels, that could be a stop run of traders offside, or recoil after a stop run. These are among many small "knee-jerks" that occur in the markets because of traders out of position. You can find pretty much universal agreement over these sorts of reactions. They are in some respects the "lowest level" reactions that generate the smallest moves. Now, you can of course use them with a bias to get in on a larger move but I am getting off track.
If you look at the opposite end of the trading spectrum, there's more of a divergence. The biggest one being the use of News. Most retail traders stick to the adage "It's all in the charts" and say many tell me "I don't want to trade the news". This is fine and my standard reply is "So how do you prevent news while you are trading?".
You can break the news into a number of key areas:
- Scheduled economic releases (like unemployment numbers).
- One-off scheduled meetings (e.g. EU changing a trade restriction, Fauci talking about COVID restrictions).
- One-off "out of the blue" news, like an attack on an oil refinery or rumors of interest rate changes
- Running news - like Covid or Brexit that keeps hitting the markets (usually with a semi-predictable outcome).
- 'Mouthy' Politicians - OK, I say this because Angela Merkel once said something 'off the cuff' that made a Bund trade slip 23 ticks past my stop. Trump tweets are in the same category.
In other words, some news is planned, some is not. The news can be used in a few ways:
- To enter a position because of the expected outcome of positive/negative news. In other words to play the sentiment. That can involve going offside if the market initially doesn't have the expected outcome.
- To play the market's reaction to the news. This is slightly different from the above but both often involve having an expectation of how the market will react to positive or negative news. Then watching and piggy-backing the move.
- To understand whether the current move is a regular swing in the market or probably because of a recent piece of news. This isn't reacting to the news. It's more of seeing a move and being aware that it may be extended/fast because of recent news.
- To stay out of the way of news completely - obviously, this is only possible with planned news.
Now, there are arguments for NOT using news. One of them is the "Efficient Market Hypothesis/Theory" (EMH/EMT) which states that the markets reflect all information known. If you believe in this, then consider the following:
- When employment numbers are really bad - why does it trigger a move that lasts the morning or all day?
- If a piece of news had someone like Fidelity dumping 100's of millions of shares - would they do it in a single sell market order?
On observation, the markets seem to take time to re-adjust to news. So I think the belief in this isn't borne out in the real world but it does give traders an excuse to ignore a lot of stuff.
The answer to the latter is "no" - they would try to get out without hurting prices too much. There are other times where everybody rushes to the doors (or the roof) because news is catastrophic.
So news creates both moves and a level of urgency. At this point, it all sounds so complicated, doesn't it? I think this is why retail traders ignore it. There is the allure with pure chart trading that once the right combination of factors is on your chart, you can then put your brain into neutral when trading. The thought of anticipating a reaction to news is quite frightening compared to the simplicity of printing money while half asleep.
So the majority of retail traders limit the scope to what is on the charts. Professionals - will use anything that appears to have a cause and effect on the market. A good example is grain traders using weather events.
Retailers WANT trading to be isolated to the charts - and I've seen people get through 20 years of trying to do that and failing. Some will stick with charts because of the "sunk cost fallacy" which means they stick with charts because of the amount of time they spent with them. Most though - they won't start incorporating news because it seems a bit scary and a lot like a huge amount of work. After all - how do you get to the point where you can predict the way the market will react to any news.
The good news is - you don't!
I am going to give a list of suggestions. They are not in any order. The idea is to become proficient at one thing and then add another. You cannot learn the dance between the news and the different asset classes overnight but then you don't have to. Add one at a time:
- Pick an economic release such as the Thursday Unemployment Claims, Wednesday Oil Inventories and keep a log of the expected numbers, the actual numbers, and the reaction in the related markets. Did it go up or down and by how much? Get a feel for the sort of hit or miss that creates a move.
- When a long-running story is in the news - Brexit, COVID, US Inflation - scan the news for announcements/press conferences for that day. Take a note of the sentiment of that news (the sky is falling/we are all saved) as well as the reaction to that news.
- Subscribe to Bloombergs "Five Things To Start Your Day" and for each news item with a time of day - write down which markets you think will react (and how), then as the news plays out, review the actuals. This may seem a bit involved but it's giving you the chance to make a call and have a feedback loop to ensure those calls get better.
- Keep your ear on the news (with tools like the news feed in Jigsaw's daytradr and Journalytix). When a sudden move occurs, if you missed the cause on the squawk, go back to the news screen to check out the news that probably caused it (if any). This way you get a great understanding of the amount of times news causes moves you can exploit.
None of these represent a lot of work and they all represent ways to start to understand how news impacts markets you trade. It's not as if you have to stop your chart work OR have to go do an economics degree for 4 years. It's just incrementally learning factors external to your charts that may move the markets.
Try it out, get a few wins under your belt. You'll soon be used to accepting there's a whole world of things that can impact markets and chart-tunnel vision isn't in the traders best interest.