This Week's Big Lesson

This week provided a lesson in trading that will serve you very well in the future. It has to do with the news and why it may affect markets.

I saw in the chat that a couple of members were using the news to gather facts and form opinions, which is great. If you're going to trade from the information available, obviously the first step in doing that is to get into the habit of actually looking in the financial press to see what's going on. The next step is deciding whether that news will have an effect on the markets and how big that effect will be.

I generally try to divide "news" into two categories-information and opinion. Either category can have an effect on the market at times-for example the BoA/CountryWide investment was "information" while the interview with CountryWide's CEO Dick Mizilo was "opinion". Let's analyze these news items further to get an idea of why there were so important to market participants.

The first step is recognizing that news regarding the housing situation is central to to market thinking. The next step is to decide if that news is realy "new". The BoA making an investment in CW at this particular time is significant. Why? Because all that anyone's heard about housing related issues have been bad. Here's the first piece of good news regarding the subject. That makes it "new" news. Aside from that, The BoA is one of the largest banks in the world. CountryWide is the largest U.S. mortage broker. Both are very important participants. Both are making "new" news that runs counter to everything that's been going on in the markets recently. This kind of thing is going to make everyone feel good, when all they've felt is bad. It changes the psychology and gives people confidence.

Next is the Mozilo interview. The whole world has been reacting to the BoA/CW story. Now he gives an interview in which he says a recession is still likely. Party over! (For now). If he wouldn't have said that-we would have seen 237 in G/J easy.

You have to realize that we are trading on probability here. We're trying to wiegh the odds and make a judgement. Mozilo makes his statement. Does it sound bad to you-does it make you feel less sure about your position. Of course it does. What are the chances that other people are going to feel that way? I would say very possible. I would say it's very possible that people are going to react to it just like you would. If it looks like crap and smells like crap-it's crap! The least you can say is that it's time to get out of your optimistic, long position and stay neutral while the effects of this can be observed.

The article that was posted in the chat has to do with Merill losing some money in their sub-prime investments. It's great that the news is being scanned and that it's being talked about. Now let's form an opinion about whether it has the potential to be truly "market moving".

Are you surprised to hear that someone is taking a loss on their sub prime investment? I would say the probability of that is low. Well surprise, you're not really all that different from any other market participant. If you're not surprised, I doubt that many others will be either. Merill may have a few points shaved from their stock's price, but the market overall is not likely to go into any big sell-off. The news about Merill is bad, but it's expected. Losing money on sub prime investments is old news. It has very little if any shock value. No one's likely to be surprised to hear that another loss was taken in sub prime, unless they just woke up from a very long sleep.

Everyone knows ducks fly south for the winter. When you see them flying north for the winter, then you have "new" news. Yes, Reuter's had an article regarding Merill, but they have a lot of space to fill and it's their job to provide as much information as possible. We're traders, so it's out job to decide if that news is likely to be market moving. If we can't decide, then we watch to see what happens. With our money off the table.