One of the things I always emphasize when I start working with a coaching student is that the markets tend to behave much more in response to the psychological than to the logical, particularly in the short to mid-term. Many retail traders seem to fail to account for the relatively high levels of emotional reactivity in the markets in making their trading decisions. As an example, have you ever noticed that is not unusual for a stock price to dip or drop right after an earnings announcement even if that announcement was not at all bad?

I am reminded of a situation that occurred several years ago. A fellow who had come to one of my seminars called one day and told me he had just bought a hundred or so short call option contracts on a company he followed and that the company was going to announce earnings the following day. I was astonished and asked where he learned to do that because it certainly wasn't from me. He responded that he knew the earnings were going to be really good. When I asked how he knew and whether he had insider information he said no, he just knew the earnings would be good. Sure enough, the earnings weren't bad, in fact just under the analysts prediction and the stock tanked. Why? I guess we can never know for sure, but that kind of action seems to occur with regular frequency when the earnings miss some analyst's predictive guess. My acquaintance lost a bundle and stopped trading.

News can certainly be a catalyst to price movement as well. As with so many of the old saws, "buy on the rumor, sell on the news" has a basis in experience. I would suggest the better approach might be to buy on the rumor and sell before the news. What really seems to occur, using the example of an earnings announcement as upcoming news, is that there is speculation, sometimes wild speculation as an earnings announcement approaches. As I am writing this article on Wednesday afternoon, August 5, 2009, for example, AIG is up over 60% before its earnings announcement on Friday. One squib I read indicated that was because analysts anticipate it'll swing to a profit. Another analyst suggested the jump was caused by scrambling shorts buying to cover positions and said there was " ...certainly no news to account for it." In either event, it is clear that speculation is extremely high on the upcoming news. Shorts are clearly fearful and longs are basking in fulfillment of their greedy side. What will the announcement be? I certainly don't know, but I do know that once it is made, we will have the answers and at that point, the questions will have been answered. The guesswork will be over and the predictions either fulfilled or they will have fallen by the wayside. In many instances (though certainly not all) once the reason to speculate is gone, the wild swings are less likely to occur. For that reason, I personally try to be aware of the dates when earnings will be announced and may make a play going into the announcement, but exit before the actual announcement.

Another example of market reaction relates to time of year. The point is analogous to the preceding discussion in that it can also relate to earnings season. Many companies announce their earnings in the month following the end of each calendar quarter, for example. So, for example, when the first calendar quarter ends in March, traders are looking forward to the earnings announcements in April. Speculative interest rises and "bets" are being placed as to how good earnings will be; whether the earnings will beat the last quarter, or the same quarter a year ago, or some analyst's guess (prediction). Once the earnings are announced, the answers are at hand and the reasons for the speculations are gone. The questions have been answered. Now, as the calendar reaches May, there is no immediate excitement about upcoming earnings reports for those companies that have just reported so, absent some other news, things are more likely to be more peaceful. The same situation applies in August, October, and February.

As with so many things in the market, I don't mean to suggest that these are hard and fast rules. In my view, they are just factors about which it may be helpful to be aware. If we take October as an example, think of the crashes and drops the market has suffered during that month over time. Last year, as one example, the Dow fell over 2600 points from the October high to the October low.

Good Trading!
Bill Kraft

Our Success Trading service delivers quality trading ideas for the elite investor that has the financial wherewithal and market nimbleness to profit on small moves in a stock's price. Become a member and you will be provided with email and/or PDA alerts intended to provide you with the opportunity to make many, many profitable trades.

Here is a play from the Success Trading Group:

FPL Group Inc. (FPL)
Our Success Trading Group is watching FPL Group, Inc. (Ticker: FPL) and we like FPL at $56.72 for new positions. We are also watching some of our other favorite stocks for possible trades next week.

Have a great weekend and we'll trade next week.
Success Trading Group Team

Our Option Trading Service is for conservative traders that understand leverage principles and enjoy the challenge of options trading. We focus on powerful option trading strategies that place volatility and momentum in your favor. And we pride ourselves on always minimizing our losses!

The Option Trader service utilizes standard trading in Puts and Calls as well as strategies using Leaps, Straddles, Credit Spreads, Calendar Spreads, and Naked Puts. But no matter how sophisticated a strategy may be, we ALWAYS know our downside potential on every trade.

Here's a look at a trade Bill is currently working on:

Direxion Daily Financial Bull 3X Shares (FAS)
I like trading these highly leveraged devices, but recognize that they can entail high risk and are, perhaps, more suited to relatively short term plays. While not for everyone, I did close a debit spread on FAS this past week to capture a before commission gain of 29% in about a month and a half.

Good Trading!
Bill Kraft