Ripped From the Headlines: How to Trade on News

Buy on good news and sell on bad, right? It's a bit more nuanced than that if you want to profit consistently.
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Tracey, a dedicated daytrader, gets up early every morning to scan the Internet for news that might drive momentum in the market. She's resourceful and smart, but two weeks ago she got burned badly by some bogus news. Hackers were able to drive up a stock by posting a fake news release on a company's Web site, until the company finally got wind of the prank and pulled the plug. That's how hot news-based momentum has gotten.

This kind of thing rarely happens, but it does go to show that although many investors realize that news drives momentum, playing the news is unfortunately one of the most misunderstood concepts in daytrading.

News is the driving force behind most of the highflying stocks that I play. Stocks react either favorably or unfavorably to breaking news, which affects momentum and creates predictable patterns. Sometimes a company releases incredible earnings or announces a fantastic new product and the stock hardly budges, while other times the CEO burps and the stock skyrockets.

Once I learned how to interpret the news, I found that my winning percentages increased tenfold. Today I am going to show you how I find, interpret and play the news.

Playing for Mo' Money: A Day in the Life of a Momentum Trader

I spend all day scanning headlines from multiple sources, including

PR Newswire

,

BusinessWire

,

Reuters

,

Dow Jones

and

CNBC

. I also input key words into a news scanner provided by my broker to alert me to the kind of news I'm looking for. My key words change depending on the sector and type of news I'm after, but here are a few I constantly keep an eye on:

  • Unexpected record earnings
  • FDA approval
  • Patent approval
  • New product revealed
  • Earnings expectations
  • Multi-million dollar pact
  • Use a smaller company's patent
  • Pacts between companies

These filters narrow down the headlines to the "high value" stories. Recognizing a good story by headline requires educating yourself. Keep a daily news log of stories you think will have huge impacts and move a stock; also note those that may not budge it one bit, or worse, may even bring its price down.

A good story should propel a stock's price more than 10%, depending on the price. Many good stories will only move the stock 1/4 point before it starts to sell off. A great story should propel a stock more than 20%. Generally speaking, a good story will have an immediate impact on the future earnings of a company, depending on its size and value. For example, a $50 million order will have little impact on a stock trading at 90 per share, but would be significant for a stock trading at 2.

I make it a point to play only the high-percentage plays -- the sure things. I'm waiting for some small, unknown biotech company to find a cure for cancer -- that's the stock that's going to soar!

Here is how I trade a good news story.

  • When a good or great news story hits the newswire, I place it immediately on the quote screen.
  • The spread must be 1/4-point or less (depending on the price of the stock).
  • I stay away from the stock if it looks like it has already gone up on a rally. I ensure the story is not old. Playing an old story is like riding a tired horse -- you never know when it will give out.
  • I do not trade a stock unless I am sure of the direction of its price. You should see a few buys at a fairly rapid pace (a buy is recognized by a trade occurring at the ask price and a sell at the bid price). This is to ensure your stock has upward momentum as you enter.
  • If I miss the trade on the initial rally price (when the news breaks for the first time) I let the trade go. I will not chase a stock.
  • I stay away from extremely fast-moving stocks. Fast-moving stocks turn quickly. When they do, every trader is trying to exit at the same time, causing delayed exit execution.
  • I exit the trade at below the full potential of the trade and I take my profits one small chunk at a time. Over time, this will be more profitable.

The Rambus Example

A good example of how to play aftermarket news this week was

Rambus

(RMBS) - Get Report

, a chip-technology specialist company. The stock gapped up (see above chart) on March 22 from a bit over 266 on the day before and opened at 324 after

Morgan Stanley

set a 500 price target on the stock. The overall market was very strong in premarket trading.

Now take a look at the second chart on Rambus the morning of March 22. It is a one-minute tick chart covering the period from 9:30 a.m. to 10:15 a.m. EST. The tick on the left side of the vertical bar shows where the stock opened up that minute of trading and the tick on the right of the vertical line shows where it ended up during that one-minute period.

I watched Rambus to see how much selling it experienced in the first 10 minutes of trading and determined it would bounce after a small dip, due to the strong market. This stock was an easy purchase at the first bottom where it dipped to 319, and took off to around 342 where it started to show signs of weakness -- my exit point. Not bad for a cool 23-point gain.

News watching can be extremely profitable, but there are many other forces affecting a stock's reaction to momentum. The key on this play was watching the amount of selling in the first 10 minutes of the opening to determine upward momentum. You must take many factors into consideration, not just the news. This is all part of understanding "market dynamics." If this doesn't whet your appetite for my upcoming series of articles on market dynamics, nothing will!

Next week, I will continue my discussion of news interpretation and then move onto an explanation of my

BusinessWeek

play.

Ken Wolff is founder and chief executive officer of Paradise, Calif.-based

MTrader.com , an interactive educational daytrading and swingtrading Web site that teaches traders how to create their own disciplined, high percentage trading programs. While Wolff cannot provide investment advice or recommendations here, he invites your feedback at

ken@mtrader.com.