traderswould not. A minute can be a lifetime in the world of trading. Afew seconds is often more than enough time to enter, exit, oreven reverse a position. The relevant question is do you haveenough time to execute a trade?125. What is the likely duration or half-life of the trading catalyst’seffect on market prices?6. Will the price move intensify or deteriorate as time passes?7. Will prices overshoot?Given the answers to the preceding questions, the trader mustthen determine the size of the position to put on. The more uncertainthe answers to these questions, other things equal, the smaller theposition size the trader will put on.Many traders think in terms of what might be called event time—that is, the market’s reaction to similar events in the past is used as aguide to how the market will likely respond to similar events in thefuture.13 Thus, a trader’s prediction of how the market will react to asecond U.S.-led war against Saddam Hussein’s Iraq is influenced by
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TRADING CATALYSTS
how the market reacted to the first such war. Although such anapproach is understandable, the market need not be consistent in itsresponse to similar trading catalysts over time. The principal problemwith the use of event time to forecast market reactions to trading catalysts is that it inevitably entails the use of a small number of observations from which valid statistical inferences cannot be drawn. Thisdrawback is unlikely to stop many traders from using event time.Another problem with using event time as a predictor of how themarket will respond to a trading catalyst is that the timing of theimpact might be off as more traders attempt to exploit the same perceived relationship. Sometimes in the rush to simplify the analysis touse event time as a guide for trading decisions, traders miss potentialoffsetting factors that make the analogy inexact.Notice that the impact of the Fed rate cut announcement was notlimited to affecting the level of market prices alone. Rather, the Fedannouncement affected both the bid/offer spread (as noted previously) and the volatility of financial market prices. This illustrates twoother ways that some trading catalysts (particularly those whose timing can be anticipated) influence trading decisions. In this way,scheduled or anticipated trading catalysts facilitate bets on changes involatility. Finally, the volume of trading often rises sharply after atrading catalyst occurs.
The Nature of Trading CatalystsVolatile financial markets create both risk and opportunity—that is,the risk of substantial losses and the opportunity for substantial gains.However, not all volatility is created equally. Sudden jumps or breaksin prices can impart a roller-coaster-ride quality to trading or investing in financial markets. This book examines the catalysts that sparklarge changes in prices suddenly or over time. These include the following, among other factors: ill-advised comments by policymakers,
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news of natural disasters, elections, certain economic reports,company-specific announcements, and factors internal to the marketitself.The direction, magnitude, speed, duration, intensity, and breadthof influence of trading catalysts on market prices are important tounderstand. It is also important to understand how trading catalystsdiffer in their influence on market prices and how the same tradingcatalyst may differ in its influence on market prices over time. Part ofthe difference in the influence of trading catalysts on market prices atany point in time, as well as over time, is a function of market conditions and sentiment, both of which are discussed in detail in Chapter2, “Market Conditions and Sentiment.”The identification of which market or markets are most likely tobe impacted by a trading catalyst seems easy but may sometimes bedifficult as the preceding Fed rate cut example shows. Again, from atrading perspective, a trader wants to take positions that will achievemaximum benefit from the occurrence of the trading catalyst at minimum risk. Imagine a trader who anticipated the surprise Fed rate cutannouncement shortly before it occurred or had advance knowledgeof it. Which market or markets would the trader have placed his betor bets on? It is not apparent that most traders would have selectedthe Nasdaq as the market most likely to have the largest reaction tothe Fed rate cut announcement. Yet, in retrospect, it is clear that along position in the Nasdaq 100 stock index or Nasdaq 100 stockindex futures was the place to be immediately following the Fed ratecut announcement on January 3, 2001.A trader needs to know the direction of the likely response to atrading catalyst to determine whether he should go long or short.Determining the likely direction of market prices in response to atrading catalyst seems easy. However, the implicit simple assumptionthat markets always behave a certain way in response to arguably thesame trading catalyst is also not true. Sometimes, there is a shift in
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TRADING CATALYSTS
how a given trading catalyst is interpreted. Sometimes, the information content of the trading catalyst is simply ignored. For example,the Merchandise Trade Balance is a monthly report issued by theU.S. Department of Commerce. Yet, as discussed in Chapter 7, “Periodic Economic Reports,” the conventional interpretation of the information content in the report changed 180 degrees between 1986 and1987. Other times, the market seemingly ignores a trading catalyst.During most of the 1990s, the merchandise trade balance report—which was so important during the late 1980s—was largely ignored bybond market participants.Financial and economic theory provides only limited guidance inhow market prices should react to various trading catalysts. Moreimportant than financial or economic theory are traders’ perceptionsof both economic theory and how other market participants will reactto the catalyst.The speed of response in market prices ranges from immediate toextensive delays. The speed of a market’s response to a given tradingcatalyst is usually fairly fast. However, as will be shown later in thisbook, sometimes there is a perceptible delay in the market’s response.In any event, the relevant question for a trader is whether there issufficient time after the trading catalyst occurs for the trader to position herself and profit from it. Other things equal, the speed of themarket’s response tends to increase the greater the liquidity andtransparency of the market.Consider once again the Fed’s January 3, 2001 rate cut discussedpreviously. Most traders, of course, did not anticipate the surpriseFed action and may not have been positioned to take maximumadvantage of it. Yet, a trader who was flat (i.e., had no position on) inNasdaq futures before the Fed rate cut announcement still had timeto put on a long position and profit from the attendant rise in pricessometime after the announcement came out. To be sure, pricesmoved quickly, but there was sufficient time to place a trade if onewas willing to tolerate the risk associated with it.
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A closely related issue is the duration of the response—that is,how long the trading catalyst continues to impact financial marketprices. The length of the impact of a trading catalyst ranges fromtransitory to permanent. The impact of many trading catalysts is fairlyshort-lived. Indeed, sometimes the impact of a trading catalyst isentirely erased in the course of a single trading session, even in theabsence of the arrival of any other trading catalysts. Consider, forinstance, the following example reported in the January 11, 2005issue of The Wall Street Journal.Energy prices have turned volatile again, driven up by theimpact of production outages and unfavorable weather thathave prompted traders to snap up oil and gas contracts…Crude oil surged to a five-week high of $47.30 a barrel duringtrading yesterday before retreating to end moderately lower,as a broad rally in oil-related futures markets stalled. Analystssaid the various production problems, combined with forecasts of cold U.S. temperatures, spurred the nearly $2 rally,but the supply snags were overshadowed by a sense that themarket had gotten ahead of itself. February crude oil fell 10cents on the day to settle at $45.33 a barrel on the New YorkMercantile Exchange…14The preceding example illustrates how two different tradingcatalysts—production outages and the weather—combined to impactcrude oil prices on the upside. Although a single “fuzzy” factor—the“sense that the market had gotten ahead of itself”—caused a pricebreak. In this case, the effects of two trading catalysts on marketprices were short-lived because the market reversed course due toother concerns. Notice that the entire gain and some 10 cents morewere supposedly wiped out by fears “that the market had gottenahead of itself.”Another dimension by which to measure the influence of a trading catalyst is the intensity of trading in the reaction to market prices
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TRADING CATALYSTS
that they induce. The intensity of trading varies from infrequent trading at one extreme to a trading frenzy at the other extreme. Theintensity of trading refers to the frequency as well as size of individualtrades.A trading frenzy might arise from either panic buying or panicselling—euphoria or despair. At first glance, one might suppose thattrading catalysts that precipitate either panic buying or panic sellingmust be very significant because of the large price changes theyinduce. However, there is no necessary relationship between the significance of the trading catalyst and the panic buying or panic sellingthat ensues. Simply stated, panic selling or panic buying need not beprecipitated by a momentous event. The trigger for episodes of panicbuying or selling may be seemingly innocuous enough. It is alsoimportant to point out that trading frenzies need not start out assuch—that is, trading may accelerate sometime after the trading eventoccurs, as it did in the Fed rate cut example discussed previously.Consider another example. News of the assassination of President John F. Kennedy on Friday, November 22, 1963 sparked a selloff in stocks and a sharp decline in stock prices that threatened toturn into a selling panic. The initial sell-off prompted the New YorkStock Exchange (NYSE) to stop trading and close early. When themarket reopened on Tuesday, November 26, stocks not only quicklyrecovered but rallied sharply higher. Indeed, in his book, 101 Yearson Wall Street: An Investor’s Almanac, John Dennis Browncharacterizes the trading activity on Tuesday, November 26, 1963 as a“buying panic” that resulted in a 4.5% gain in the value of the DowJones Industrial Average.This episode is interesting from another perspective: namely, howa news-oriented trading catalyst, the assassination of PresidentKennedy, which was only partially responded to because the marketwas closed early, can be quickly followed by a larger, and arguably,reflexive trading catalyst. Although it is impossible to know how far
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the Dow Jones Industrial Average would have fallen if the NYSE hadnot halted trading early, the sharp rally on Tuesday, November 26,1963 illustrates the powerful impact that purely reflexive trading catalysts can exert on market prices.At the other extreme is a slow market with infrequent trading following the occurrence of a trading catalyst. These catalysts are relatively rare but may occur when prices jump to reflect the impact ofthe trading catalyst without inducing additional trading activity. Avariant of this is sometimes observed in satellite or related marketswhere there is a considerably more muted reaction than occurs in theprimary market, even after adjusting for any differences in risk.Another dimension of the impact of trading catalysts is thebreadth of the market’s reaction—that is, whether the response to atrading catalyst is localized (i.e., limited to one market or one sector)or generalized (i.e., affects multiple markets). In other words, a trading catalyst in one market can act as a trading catalyst for prices inanother market. A frequent example in this regard is the impact thatchanges in oil prices have on equity prices and the impact that pricechanges in the equity market have on other markets. The reaction ofother markets may be quick or slow.Consider the following example reported in the Thursday, October 28, 2004 issue of the Financial Times.World oil prices dropped sharply yesterday after the USreported a bigger than expected rise in crude stocks…sendingequity prices scurrying higher.The dollar climbed broadly…as the fall in oil prices alleviatedthe threat to the US economy posed by further rises in energyprices.Nymex crude oil futures fell swiftly as news of a bigger-thanexpected rise in stocks of crude oil and gasoline outweighed afall in heating oil stocks…
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Nymex December crude fell almost 5 per cent to $52.46 perbarrel……The Dow Jones Industrial Average gained 1.2 per cent to10,002.30…The Nasdaq Composite put on 2.1 per cent.Yet while oil was the clear catalyst for yesterday’s gains, nextweek’s presidential election, the result of which is too close tocall, is casting an uncomfortable pall over financial markets…15There are several lessons to be gleaned here. First, it is importantto understand that every trading day new catalysts can impact themarketplace. Consequently, some trading catalysts may have shortlives. Second, other trading catalysts—like the impending presidential election in the U.S.—could exert an influence on day-to-daytrading and otherwise color the market environment for some time.The underlying concern—in this instance, the uncertain outcome ofthe impending U.S. presidential election—could dampen the overallsensitivity of equity prices to oil price changes. Third, notice that themarket seemingly chose to ignore certain information, namely thedrop in heating oil stocks.Trading catalysts can be defined in a number of different ways.The approach taken in this book is to divide trading catalysts into twoprincipal categories: those external to the market and those internalto the market. External trading catalysts can be further subdivided asfollows: the comments of policymakers and politicians; domestic andgeopolitical risk; weather and natural disasters; scheduled economicreports; unscheduled economic news; earnings announcements,court or regulatory decisions, and other company-specific news;rumors; and noise—non-fundamental factors that affect pricesamong others. Internal catalysts can be subdivided into the following:reflexive catalysts; cases where trading feeds on itself and exacerbatesthe price move (i.e., positive feedback trading) because of stop lossorders being hit, margin calls being made, or perceived technical barriers violated; and cases where price changes in one market spill overand affect price actions in other markets.16 The latter category
CHAPTER 1 • INTRODUCTION
17
includes cases where the price action in foreign markets affects thesubsequent price action in domestic markets as well as cases wherethe price action in one commodity, say crude oil, affects the priceaction in the stock market. Other ways of categorizing trading catalysts also exist.One might classify reflex rallies as being precipitated by internallygenerated trading catalysts. However, the spark that causes the rally ismore frequently a change in market perception rather than a specificevent marking the end of the panic and a reversal of opinion. This isillustrated in the historic behavior of U.S. stock prices as measured bychanges in the Dow Jones Industrial Average. Significant price reversals oftentimes seemingly come out of nowhere. John Dennis Brown,who examines the behavior of the Dow Jones Industrial Average from1890 (the first full year that statistics were available) through 1990 inhis book, 101 Years on Wall Street, includes a list of important oneday buying panics.17 These days are associated with substantial positive percentage changes in the Dow Jones Industrial Average rangingfrom a low of 4% to a high of 15.3%. Brown categorizes the rallies as“news-oriented,” “war-influenced rallies,” and “reflex from panic conditions.” Of the 29 examples listed, 12 are classified as reflex ralliesfrom panic conditions.18Two examples of reflex rallies are the 12.3% rally on October 30,1929 following the market crash of October 28 and 29, 1929 and the10.1% rally in the Dow on October 21, 1987 following the marketcrash of October 19, 1987. As noted earlier, one problem with usingevent time to predict future market sensitivity to trading catalysts isthe small sample sizes that one has to deal with. The idea that pricesshould recover some of their losses from a major sell-off or marketcrash seems reasonable but, once again, the sample size is too small todraw valid statistical inferences from. Nevertheless, when the nextmarket crash occurs, many traders may be looking for a major shortterm rally following the crash based on what has happened inresponse to previous market crashes.
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TRADING CATALYSTS
Probably most individuals would argue that news-oriented ralliesor sell-offs would exert more impact on market prices than reflex rallies or breaks would. However, that need not be the case. Anotherinteresting aspect of John Dennis Brown’s list of important one-daybuying panics is that many of the news-oriented rallies had a smallerimpact on market prices than the reflex rallies did. This highlights thedanger of relying on the arrival of new information to explain largemoves in market price.The preceding division of trading catalysts into external and internal factors is sometimes problematic. Consider, for example, a situation in which crude oil prices surge due to production disruptions alsoresults in equity prices falling because of the fear that higher oilprices may have on the overall economy. Under the preceding definition, the trading catalyst for the oil price move would be classified asan external factor but the trading catalyst for the equity price movewould be internal—namely the rise in crude oil prices. The relevantissue is whether the price changes in one market are driving the pricechanges in another market or whether fear has simply spread to othermarkets.Another way of categorizing trading catalysts is to decomposethem into informational and noninformational factors. A proponentof the efficient capital markets hypothesis would argue that only thefirst category should impact market prices. However, both types oftrading catalysts exist. And, noninformational factors sometimes havea larger impact on market prices than fundamental news.
Do Perceived Trading Catalysts ReallyInfluence Market Prices?Most observers would regard a surprise Fed announcement of a targeted Fed funds rate cut as an unambiguous trading catalyst. This isnot always the case for all trading catalysts. Sometimes, the trading
CHAPTER 1 • INTRODUCTION
19
catalyst that sparks a large move in prices may be a matter of contention. Other times, trading catalysts that have regularly sparkedlarge price moves in the past occur without any appreciable responsein market prices. An example in this regard is the inconsistent impactthat large changes in crude oil prices have on the equity market.Trading catalysts that spark large and sudden changes in marketprices are more readily identified than trading catalysts that sparksmall changes. However, sometimes trading catalysts spark smallchanges in market prices immediately but accumulate to a largechange over time. This category of trading catalyst may also have aneffect on market prices by reinforcing market sentiment and therebyhelp create the conditions for a more abrupt change in prices later.There is a natural human tendency to impose order on apparentchaos. This tendency applies to attempts to explain financial marketbehavior as well. This is especially true for large price changes. Intuition suggests that there must be a reason for a large price change.Most of the time there is. For instance, few observers would disputethat news of the Federal Reserve rate cut sparked a rally in equityprices on January 3, 2001. However, sometimes large price changesoccur for no apparent reason. This occurs more frequently than onemight think. During 2000 and 2001, there were a number ofinstances where the Dow Jones Industrial Average or the NasdaqComposite changed by 3% or more from the previous trading day.Yet, there is no readily identifiable source for many of these pricemoves. These large price moves may be the result of internal tradingcatalysts discussed in Chapter 8, “Size Matters,” and Chapter 9,“Bubbles, Crashes, Corners, and Market Crises.”The lack of a readily identifiable source for many large pricechanges may explain the sometimes seemingly inconsistent behaviorof market prices in response to certain trading catalysts over time. Itmay also explain how seemingly innocuous events can precipitatelarge price changes.
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TRADING CATALYSTS
The preceding discussion assumes that there is only a single trading catalyst affecting the market at a given moment in time. It is possible that there may be several competing trading catalysts of whichthe news media only highlights one or two. Multiple trading catalystscould reinforce or offset one another. This may also explain apparentinconsistencies in the impact of the same trading catalyst on marketprices over time. Isolating the individual market impact of multipleconflicting trading catalysts would likely be difficult. In any event,perhaps more important than the potential existence of multiple trading catalysts is whether most traders perceive (correctly or incorrectly) that trading activity is being driven by a single trading catalyst.The question naturally arises as to whether the attribution byjournalists of a large price move to a given trading catalyst is accurate.After all, journalists are expected to provide their readers, viewers, orlisteners with informative explanations of what prompted a marketmove. Are the explanations in media accounts accurate descriptionsof the causes of price moves, or are the reported catalysts simplyrationalizations or excuses traders use for doing what they intended todo all along? There are two aspects to this question. First, is thereported trading catalyst the correct reason for the price action? Second, if so, what fraction of the price move is explained by the presumed trading catalyst?To be sure, news media stories typically try to account for theprice action of the entire trading day rather than focus on theimmediate reaction to the trading catalyst. In addition, news mediaaccounts of the impetus of a given price change may also be biased bythe choice of whom the media interviews or obtains its informationfrom. In any event, it is often impossible to determine the fraction ofa market’s reaction that can be attributed to a given trading catalyst.That said, contemporary news media accounts of the apparent causesfor large changes in prices, although not perfect, provide a good summary of the perceived causes of large price changes during the day.
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If the reported causes of large price moves are simply rationalizations by traders for doing what they already intended to do, themarket-moving power comes not from the arrival of the trading catalyst but from the acquisition, hedging, or unwinding of trading positions and the trading they induce. Although it is possible to “explain”virtually any price change, it is worth noting that the puzzling behavior of financial prices is not confined to cases with ambiguous tradingcatalysts. As the opening example in this chapter demonstrates, thebehavior of financial market prices in response to unambiguous trading catalysts is also sometimes puzzling. Moreover, there are numerous examples of puzzling market reactions to various trading catalyststhat will be discussed in this book.
Trading Catalysts and Market EfficiencyThe perceived influence of trading catalysts on market activity is intimately intertwined with the notion of market efficiency. In an informationally efficient financial market, prices change only with respectto the arrival of new information.19 There are varying degrees of market efficiency that reflect differences in the amount of informationavailable to market participants. This decomposition is due to EugeneF. Fama, who divides market efficiency into weak form, semi-strongform, and strong form.20 Weak form market efficiency refers to a market whose current prices reflect any information contained in theseries of past price changes. The principal implication is that certainforms of technical analysis, such as trend following, should not beprofitable. Semi-strong form market efficiency refers to a marketwhere prices fully and correctly reflect all publicly available information. In such a market, an individual cannot profit from investingon publicly available information. Strong form market efficiencyrefers to a market where prices fully and correctly reflect all available
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TRADING CATALYSTS
information public or private. In such a market, it is not possible toconsistently earn a superior return. Market efficiency does not suggestthat it is impossible to earn superior returns. Rather, it suggests that itis not possible to consistently earn superior risk-adjusted returns.21There are several implications for trading catalysts if the marketis informationally efficient. First, true trading catalysts would be limited to the arrival of new information in the marketplace. Priceswould not respond to noise—non-fundamental factors that influencemarket prices. Second, the impact of trading catalysts on marketprices would be immediate and complete. Prices would jump or fallinstantaneously upon the arrival of new information. Third, the market would interpret any information content of trading catalysts correctly. Prices would not react to a trading catalyst and then a fewminutes later return to where they were before the announcementunless new information entered the marketplace during the interim.There is a considerable amount of evidence in the financial economic literature that suggests that changes in financial market pricesdo not follow a normal or lognormal distribution. Rather, changes infinancial market prices seem to be drawn from a distribution that isleptokurtic—a distribution that has more probability mass in the center and in the tails than the normal distribution does. This means thatlarge price changes should occur more frequently than they wouldunder a normal distribution. A stock market crash of the magnitudeof either the 1929 or 1987 crashes should almost never occur ifchanges in stock prices are normally distributed. Even mid-singledigit daily returns are exceedingly rare in a normal distribution.22 Theobservation of two stock market crashes in U.S. equities during thetwentieth century and numerous days with high single-digit percentage price changes serve as a useful reminder of the practical importance of the distribution of changes in stock prices. It is also a potentreminder of the power of trading catalysts.There is also a considerable amount of evidence in the financialeconomic literature that suggests that the volatility of changes in
CHAPTER 1 • INTRODUCTION
23
financial market prices tends to both cluster and persist. This leads tothe question of whether trading catalysts also cluster. The answer tothis question depends on one’s view of what causes prices to fluctuate. Individuals who subscribe to the efficient markets hypothesiswould argue that trading catalysts cluster because the arrival of newinformation, and hence volatility, clusters. Market participants whodo not subscribe to the efficient markets hypothesis would tend todisagree. They might argue that the more frequently trading catalystsoccur, the more potential there is for trading catalysts to reinforceone another and increase perceived volatility.
Trading Is a GameActive financial markets are invariably dominated by traders and trading activity. Although traders and investors share the same objective—to make money—they frequently differ in their approach to decisionmaking. These differences matter and can influence the short-termbehavior of market prices. It is important to understand that trading isessentially a game. The objective—to make money—remains constant, but the “rules” change over time. John Maynard Keynes put itthis way:[P]rofessional investment may be likened to those newspapercompetitions in which the competitors have to pick out thesix prettiest faces from a hundred photographs, the prizebeing awarded to the competitor whose choice most nearlycorresponds to the average preferences of the competitors asa whole; so that each competitor has to pick, not those faceswhich he himself finds prettiest, but those which he thinkslikeliest to catch the fancy of the other competitors, all ofwhom are looking at the problem from the same point ofview. It is not a case of choosing those which, to the best ofone’s judgment, are really the prettiest, nor even those whichaverage opinion genuinely thinks the prettiest. We have
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TRADING CATALYSTS
reached the third degree where we devote our intelligencesto anticipating what average opinion expects the averageopinion to be. And there are some, I believe, who practicethe fourth, fifth and higher degrees.23When viewed as a game, some of the apparent inconsistenciesand anomalous behavior in the reaction of market prices to tradingcatalysts appear more understandable. There may not be a rationalexplanation for all market reactions. The point is, to paraphrase legendary trader Richard Dennis, markets need not make sense.24
Trading Off of CatalystsThe timing of certain potential trading catalysts is known in advance.Examples include the release of periodic economic reports, elections,and certain presentations by politicians and policymakers. This allowstraders the opportunity to position themselves in advance of thepotential trading catalyst. It also provides more time for consensusexpectations to form. And, it is the forecast error (the differencebetween consensus expectations and the actual results) that the market will respond to. One consequence of more precise consensusexpectations is a smaller forecast error. In turn, this suggests a smallermarket response for scheduled potential trading catalysts, otherthings equal, than for unscheduled potential trading catalysts.Scheduled potential trading catalysts have another impact ontrading activity, and that is to alter the timing of entry or exit of positions unrelated to a bet on the potential trading catalyst. For instance,the release of the monthly employment report by the U.S. Department of Labor often affects the bond, stock, and currency markets. Atrader who wants to enter or exit some market might delay or accelerate doing so in order to avoid being stopped out from a positionbecause of an adverse move caused by the release of a report that hedoes not have an opinion on.
CHAPTER 1 • INTRODUCTION
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In contrast, the timing of other potential trading catalysts may beunknown, but the outcome is fairly well-known. An example in thisregard would be the invasion of Iraq during 2003. It was readilyapparent to many observers that the Bush administration had alreadydecided to invade Iraq months before it did. However, the timing ofthe action was uncertain to market participants. Another examplewould be the decision to end the 1:1 peg of the Argentine peso to theU.S. dollar. By late 2001 it was clear that the link would be broken;however, it was not clear as to when the peg would be ended.The timing and content of many trading catalysts is unpredictableso that a trader cannot position herself in advance to take advantageof the perceived opportunity. Is it too late to profitably trade after atrading catalyst occurs? Not necessarily. Trading opportunities alsoexist after a trading catalyst occurs. Again, the nature and extent ofthe trading opportunities depend on the magnitude and duration ofthe market’s reaction to a trading catalyst. In some cases, the marketreaction may allow plenty of time to put a position on (albeit at lessfavorable prices than before the trading catalyst occurred). As notedearlier, a trader does not need a lot of time to put a position on or takea position off.Not only is the timing or content of certain trading catalystsunpredictable but sometimes so is the market reaction. The FederalReserve’s cut in the targeted Fed funds rate illustrates the conventional view of the impact that a surprise central bank rate cut wouldhave on equity prices. As will become apparent in this book, the market’s reaction to trading catalysts is not always so predictable. As willbe shown in the next chapter, market conditions and sentiment biascan influence the magnitude and duration of the market’s response toa given trading catalyst. This adds a dimension of risk when tradingoff of scheduled economic reports and other potential trading catalysts whose timing is known in advance.The opening example of a cut in the targeted Fed funds rate bythe Federal Reserve illustrates a case where the price reaction is both
26
TRADING CATALYSTS
relatively quick and large. Yet, as was noted, there is still time to put aposition on. Sometimes, the reaction to a trading catalyst may not beas quick. Indeed, in some cases, the timing of the trading catalyst maynot provoke an immediate reaction in market prices—that is, thereaction may be significantly delayed. Several examples of delayedreactions to events are discussed in the book. Delayed reactions create confusion over what the proper reaction to a trading catalystshould be but also create opportunities to put a position on.In the January 3, 2001 Fed rate cut example, the impact on Nasdaq stock index futures prices