KNOW ANY CORRELATIONS

If you are trading stocks you should know if they are part of the major
indices and how a move in the indices correlates to the stock. It need not
be exact but you should know that if the Dow drops 100 points your stock
would normally drop $1.50 or that a dollar move in your stock will move the
Dow 11 points. Sometimes it’s easier to look at the markets as a whole and
get a determination of what a stock may do, instead of trying to figure out
what a stock may do on its own. And if you knew the correlation between
the two, you could time your trades a little better or know if a stock is
stronger or weaker than the market.

You can look for correlations between stocks in a sector, or commodities
and the price of gold, or oil, or the dollar, or between commodity
groups like heating oil vs. crude oil. Many people trade the stock market
based on what the bond market is doing. Many things affect different markets
and there are correlations all over the place. The better you know
them, the better you become as you may pick something up just a little
faster if you are aware of them.


Are They Laggards or Leaders?

This leads me to another factor you should know when trading and that is
whether the stock or market is a leader or a laggard. Within every sector
there are the stocks that make the sector move first and there are others
that move once the sector becomes active. Some stocks move in sympathy
with other stocks, like if one bank has great earnings and rallies, the other
banks will follow as well. It’s good to know these things and which stocks
do what as it will help you find opportunities to trade.
This isn’t just true within sectors but in the market as a whole. There
are some stocks that can move the market by themselves. Well, not by
themselves, but so many other firms react with these stocks that it moves
the market, and the one stock was the catalyst that made it happen. These
are usually the big name stocks with huge volume. If a company like Bear
Stearns has a bad earnings report every other bank may drop, as well as
many other firms that depend on the banks, which can create a snowball
effect and start an avalanche. I’m not telling you not to trade these stocks
but be aware that sometimes the big safe stocks can be riskier to trade than
the stocks that are laggards.

I used to trade at a firm that never liked it when people traded the
leaders. They thought it was too difficult to compete with all the big players
in those big stocks. Instead they preferred to find small and mid cap
stocks with volume of 100,000 to 500,000 shares a day that would follow
the moves. They had less competition and more time to react and felt they
could trade better, and this is how they taught new traders. I never liked
doing it, which is why I left, but it worked for them.

What Moves It?


Though I’ve always been a technical trader and barely looked at the news
to trade, as I write this chapter I’m realizing how important being better educated
can be. I still believe that everything is reflected in the price and that
news may not help you react any quicker, but if you know why something
did something, then you can be better prepared to exit a position when
that condition is over. As a trader you should be aware of what moves the
markets you trade. There are many factors that can cause a commodity or
stock to move and you should be alert to them. Some of the things you
should know are:

Which Reports Can Do What and When Do They
Come Out?

There are so many reports that I’m not going to bother to list them, but an
example or two are crop reports that will move the grain markets and the Consumer Price Index report, which can move the whole stock market and
different stocks in several ways.

When Do Earnings Come Out and What to Do
with Them?

Not only should you know when earnings come out, but you should learn
how to read a stock’s reaction to them. Good or bad earnings is not important
to me, it’s how the stock reacts to that report that is key. Don’t
get caught with your pants down because you did not know the stock you
shorted last night has earnings due today before the open.

How Do Markets React to Changes in Interest
Rates and Foreign Exchange?

One of the most anticipated things in the market is the Federal Reserve’s
announcement on interest rates. A cut or hike greater or smaller than expected
can trigger a huge move in a stock, future, sector, and whole market.
But not all sectors and stocks react the same way, as some sectors react favorable
to higher interest rates while other do not. You should know what
a change in rates will do to the stuff you trade. And of course you should
know when these announcements are due. Changes in foreign exchange
can have more subtle effects on some markets, but nevertheless you should
know if the stocks or commodities you trade are sensitive to them. As the
U.S. dollar drops, gold will most likely go up. Cocoa is a market that can be
affected by the British pound because London cocoa futures trading, which
have a huge impact on worldwide prices, is conducted in British pounds.
So, big fluctuations in the pound will impact the price of U.S. cocoa futures,
due to the cross-currency fluctuations of the British pound vs. the
U.S. dollar. There is constant arbitrage taking place between the New York
and London cocoa markets so the rate between the pound and the dollar is
very important. This is something the average person may not be aware of
but it’s good to know.

Is the Market Weather Sensitive?

Orange juice, oil, grains, the softs (coffee, sugar, cocoa, and cotton), cattle,
and a few more, are very much weather-related products and a frost,
drought, flood, or heat wave can send prices soaring in some markets. Or a
slightly different weather pattern can send one market up while sending another
down. Keeping abreast of the weather can help you determine which
direction you want to be trading some markets. Hurricanes or threats of
them, for example, can cause large moves in the oil markets and soft markets, but may not have any effect on cocoa, which is not made in the
area affected by the hurricane.