Trading the News

There’s no shortage of financial news, to say nothing of the reaction to it. But how should you trade in response to such information?

Let’s look at the four most common types of “news” moving the markets today and how you could position your trades to ride the ripple effects.

1. Corporate earnings

  • The release: Quarterly earnings reports can trigger some of the most volatile—and potentially profitable—periods for trading a company’s stock. The key here is usually how the numbers compare with analysts’ expectations. However, many companies appear to be conservative in their estimates ahead of their releases, which can often lead them to exceed expectations. In fact, in the first quarter of 2021, 86% of S&P 500® Index companies reported better-than-expected earnings, according to the financial research firm FactSet.
  • The response: Consider waiting to trade on earnings until after the company-hosted call, during which officials may talk about the underlying health of the business, revise their outlook for future earnings, or reveal other data not made available in the earnings release. For example, when social media giant Twitter posted better-than-expected first quarter earnings in April 2021, its stock still plunged more than 15% after its forward-looking guidance fell short of expectations (see “Sudden drop,” below).

2. Economic data

  • The release: U.S. government agencies periodically report various data on the health of the economy. Generally speaking, the most tradable are:
    • Weekly initial jobless claims
    • Monthly Consumer Price Index data
    • Monthly retail sales figures
    • Monthly jobs report
    • Quarterly gross domestic product estimates
  • The response: Again, be mindful of expectations when trading in response to economic data. Many news sites report economists’ consensus outlook ahead of time, and the market will often move—at least initially—based on whether the numbers are better or worse than the median estimates. However, sentiment can change once investors have had a chance to dig into the details, so beware of trading on the data too soon.

3. Fed announcements

  • The release: Tracking the Federal Reserve and the direction of monetary policy isn’t just about trading on rate hikes or cuts. While those decisions—made by the Fed’s rate-setting Federal Open Market Committee (FOMC)—are important, they are often widely telegraphed by Fed officials ahead of time. What’s most influential is the FOMC’s forecast for interest rates and other policies moving forward.
  • The response: Traders should keep an eye on the statement that accompanies the Fed’s rate decision after each of its eight scheduled meetings every year; even slight changes in wording from meeting to meeting can lead to significant market moves. Similarly, changes to the Fed’s dot plot—which represents the view of each voting member for the federal funds rate target range—can influence stock prices. Traders also should look for changes in tone when Fed Chair Jerome Powell holds a press conference after each FOMC meeting. Following the June 2021 meeting, for example, stocks fell after Powell said Fed officials were “talking about talking about” tapering—a reference to a potential slowdown in the pace of the central bank’s monthly bond purchases since the pandemic began.

4. Federal fiscal policy changes

  • The release: Unscheduled policy announcements can have a dramatic impact on stock prices. Unfortunately, by the time actual legislation is approved—if it’s approved at all—it’s usually already baked into valuations. The Biden administration’s $2 trillion infrastructure proposal, for example, helped boost industrials in the first half of 2021, but subsequent compromises reduced the scope of the proposal—and with it, investor enthusiasm for the sector.
  • The response: Those looking to capitalize on potential policy shifts should heed the adage, “Buy the rumor, sell the news.” That is, consider entering a trade around the time the policy is announced—when expectations are often at their peak—and exiting before that blue-sky proposal is inevitably brought down to earth.

General rules of the road

In addition to the tips above, it can be helpful to try the following tactics:

  1. Narrow your time horizon: In most cases, you’ll want to get in and out of trades within a few days or even a few hours, lest other price-moving developments derail your original thesis.
  2. Protect your downside: Whenever you take on a new position, consider entering a stop or stop-limit order that indicates how far you’re willing to let a stock slip before you sell. While these risk-management tools won’t protect you from after-hours or premarket moves, they can help mitigate the damage if a trade moves against you during the day.
  3. Limit your exposure: Many traders restrict their shorter-term trading positions to no more than 20% of their total portfolio—with no more than 5% wrapped up in any one trade.
  4. Go broad: Consider exchange-traded funds, which grant you access to large or small swaths of the market; in some cases, they’ll even allow you to short parts of the market if you expect bad news.

And remember: Letting a little time elapse after news breaks can bring clarity—and even a complete reversal in an individual stock or the broader market—so don’t jump the gun if you aren’t feeling confident in your reading of the latest news.

About the author

Randy Frederick

Managing Director of Trading and Derivatives, Schwab Center for Financial Research