Options Trading Idea of the Week
The "Buy on the rumor" adage:
What rational explanation can there be for the market to go up by almost 3% on a single day when the big news was a job loss of 598,000, the largest loss reported in several decades? The answer is that there isn't any rational explanation. Isaac Newton once said "I can calculate the motions of heavenly bodies, but not the madness of people." The market is emotional, not rational.
Once again, the old Wall Street adage "Buy on the rumor and sell on the news" seemed to be at work. The rumor was the possibility of the stimulus package being passed. Will the market turn around and move lower once the package becomes a reality? Investors carried out the first part of the adage, and it will be interesting to see if they follow through with the second part.
The adage has its roots from the 1950's when a lot of merger activity was taking place. A study showed that in the few months before a merger was announced (but was rumored), the stock outperformed the market in general, but once the merger was announced, the stock underperformed the market. The best strategy was to buy when the rumor started circulating, and then sell as soon as the news became public.
I could not find any studies that supported the adage since the 50's study, but it has persisted nevertheless. I think it is just something for analysts to pull out when there is absolutely no rational explanation they can think of to explain why the market did something like what it did on Friday. It really doesn't make any rational sense. Once again, we are reminded that the market is primarily an emotional beast rather than a rational thinking intellectually evolved animal.
Terry
Andy's Market Report
Last week I mentioned the following: "seasonally speaking the last two trading days of January and first five trading days of February have been overwhelmingly positive for the market with 17 out of the last 20 years. If that is the case and history does happen to repeat itself this time around we should expect to see some decent gains next week."
Well, history did repeat itself this past week making it 18 out of the last 21 years that this seasonal phenomenon has been kind to the bulls.
What now? Okay, for starters the market is currently in a short-term overbought state so a short-term reprieve typically follows. Furthermore, on Thursday we experienced an interesting occurrence that has occurred only 20 other times in the S&P 500 (SPY).
On Thursday, the market gapped 1% lower only to close the day higher on a 10% increase in volume. This has occurred five other times during the current bear market and the results over the next five trading days have certainly not been positive for the market. All five occurrences had negative returns.
Moreover, when the S&P 500 (SPY) has pushed higher 1% or more the day before a Non-Farm Payroll report, then proceeded to gap up on the day of the report the S&P finished the day up roughly 70% of the time. Although, if you decided to purchase SPY at the close of the day of the announcement there was only a 21% win rate the following day and even less going out three days.
All of these statistics do not guarantee that a move to the downside is guaranteed, but it does increase the probability of a move to the downside. Remember, there are no guarantees in this wonderful world of trading, if there were you probably would not be reading this right now.
Friday was the big day for economic announcements for the market and the result was not good. It wasn't even close to good. It was downright horrible. The nation lost 598,000 jobs (the most since 1974) in the month of January which pushed the unemployment rate to 7.6%, the highest since 1992. Worst of all, the end does not seem to be near as the rate seems to be on track for a double digit reading in the upcoming months.
"The job market is unraveling," Zandi said. "Businesses are panicked. They are fighting for survival and slashing payrolls to conserve cash, and there's no sense this is going to stop any time soon."
During 2008, the job market lost a total of $2.9 million jobs which marked the largest annual decline on record.
"Gird yourself," said Ken Mayland, president of ClearView Economics. "We'll be seeing some just awful numbers on the economy for the coming months."
So why did the market rally on such poor numbers? One word: stimulus. "These numbers demand action," Obama declared, urging Congress to waste no time in completing work on the economic recovery package.
"If we drag our feet and fail to act, this crisis will turn into a catastrophe. We'll continue to get devastating job reports like today's month after month, year after year."
Indeed the stimulus package and the government's latest revision to the lifeline for banks helped the market shrug off more poor economic reports this past week. Treasury Secretary Timothy Geithner stated that they were close to completing an overhaul of the TARP funds and he is expected to announce these changes on Monday. The question is will this be enough?
"All focus right now is now is really on Washington," said Dan Cook, senior market analyst at IG Markets in Chicago. He said investors are hoping the unemployment report was bad enough to goad lawmakers into swift action on the stimulus plan.
One thing is certain next week will be an interesting one for the market. Stay tuned!
Overbought/Sold Condition Report
Overbought/Oversold as of February 6, 2009
Major Benchmarks
- Dow (DIA) - 64.8 (neutral)
- S&P 500 (SPY) - 70.0 (overbought)
- Russell 2000 (IWM) - 68.9 (neutral)
- Nasdaq 100 (QQQQ) - 80.0 (very overbought)
- Oil Services (OIH) - 74.3 (overbought)
Testimonial of the week
Bravo for Terry! Over the past months while the markets in general have tanked and had historically high volatility, Terry's strategies have managed to show impressive gains in several of his portfolios. He has developed a method for making profits with options, even when the markets are gyrating in huge ranges and the typical investor is experiencing painful losses. ~ Mary Ann Norfleet, Ph.D.