Stockradar: Leighton (LEI)
May 20, 2010
To the novice the seemingly conflicting forces of a good result followed by a fall in the share price seems at odds just as a bad result is often followed by a rally, and there our stock market reality awakening begins. We all need to learn, gain experience, or find a mentor to help us trade the stock market successfully just as we would with any other field that requires expertise to achieve success.
With a dearth of opportunities jumping out at me it seems like a good point to distract you from a market that is presenting us with a high risk trade environment and dangling dangerously at a major support level and offering plenty of opportunities to lose your money so I’d like to discuss how the market and prices work in relation to new or unexpected news why we use charts to help us and use the recent Leighton (LEI) report and outlook as an example.
Buy the rumour sell the fact about sums it up or buy the expectation and sell the reality and this to a newcomer is difficult to comprehend as why would a stock’s price go down when it delivers a good result or rally on a poor one. The answer is that the market is in a hurry and can’t wait for you as it immediately discounts all known news and only responds to new information. So we all need to think about this as traders because what we know now is relatively useless information and has already been discounted by the market! This implies that to trade the market successfully we have to look into, or try to look into the future. Impossible. But in effect we need to be able to find a way do that to successfully trade the stock market. That’s what we’re all up against. Now would be a good time to walk away if that seems too difficult and the current market is certainly making that an attractive option. But there is a way and if you’re prepared to learn and do the work you will succeed!
But firstly the discounting process goes something like this. When we buy or sell a stock we don’t actually buy or sell the fact of what the stock has done up to now as any upcoming “old news” reports will reflect. No we are buying/selling an expectation that the price will move in a certain direction because of what we think is going to happen next be it based on your gut, price information, fundamentals, or the big one the “rumour” or unsubstantiated report. So do we need a crystal ball to foretell the future so we can trade on that? Yes but we don’t have one so we have to find another way.
If the stock we have bought on our expectation doesn’t rally that’s a disappointment and we usually, or should, then reverse our position by selling, because others will! The reason we buy is what we think is going to happen and what has happened won’t do it because we all know it and have bought and sold accordingly. So by the time a report reaches the market the consensus is usually well and truly discounted by the market in that anyone who was going to buy into the expectations of (good) report will have done so before the report reaches the market and thus all that are really left are sellers. With no buyers left to react to a good report the price inevitably then falls.
The opposite price effect is, and this refers to the LEI case, when the report doesn’t come in to a consensus or expectation range and thus is delivering bad news that has yet to be reflected by the price. The result, the price will move to reflect that new information. LEI’s reported outlook had a few surprises but ultimately was far worse than expected or hoped for and in this case adversely affected the price because the expectation was for a fair result and it came in a lot worse based primarily on the forward outlook. The price thus moves down accordingly. An upside surprise can just as easily occur because it is new information the buyers and sellers can respond to and the releasing of reports and more importantly the outlook is always a critical price point because you have a focus on one event at one point it time that allows investors to make a move, and they often do. That’s why volatility often rises sharply at these times.
An above expectations result will attract a scramble for stock because at this point in time the wave will be strong one way, in this case buyers, with little resistance from the other side, the sellers, because they too are surprised by an out of consensus range result and probably step back clearing the way for the price to rise.
Alternatively a downside surprise i.e. the report is worse than expected will bring a swathe of selling and the price drops like a stone which LEI’s has done. The stock market is a funny old game but the basic premise to work on is that the stock market discounts all known news and is always looking ahead as to what might happen next and thus only reacts to new information. That makes it seem hard because we have to try and read or foretell the future which of course we can’t. It goes some way to explaining why we can’t always be right and of course why the experts don’t know as they profess. Why they set themselves up with this presumption is a wildly extraordinary need. (Something to do with making money, but not from the stock market, from you!).
The only saving grace is that the market does go one way the majority of the time but this can lull us into thinking we are infallible experts as we gear up to the hilt - until the bear market arrives. The stock market’s actually a game of odds based on reading the demand and supply equation and that is the greatest attribute of what a chart presents us with. We all need to take another look at how we trade the stock market because many of the irrelevant tangibles we hang on to most of the time are poppycock and the recent bear market should reinforce that in your minds. We all need to be constantly prepared and there are common sense ways to beat a stock market and the highly useful and effective first premise I base my trading on is that I have no idea what is going to happen next because none of us actually do. But it makes my life an awful lot easier not having to answer that interminable question and to make money on the stock market you simply don’t need to know.
What gives me a clue is price behaviour because it has repetitive demand and supply connotations that precede predictable price moves that we can base trades on. Those that decry this method that is gaining growing acceptance as a highly useful trading tool simply don’t know how to do it or accept the underlying premise that price behaviour is based on repetitive human behaviour and that’s what drives the stock market. Bear markets and their extent are driven by you the human not the stock itself. We look at simple demand and supply of a stock and this in itself has great predictive qualities. What price analysis can do is not provide a crystal ball but a very strong and educated assessment of what is more likely to happen thus providing a odds case of one thing (up or down) being more likely to happen than another and we can all trade on that basis successfully. And therein lies my crystal ball or market edge and that’s what I trade repetitively just as a casino plays its market edge – repetitively and we all know how much money they make!
LEI fell out of bed just after our stop loss was hit. We won this round as the market reacted to the poor outlook statement by LEI which the market obviously was not expecting! Thus the price movement. And by winning here I mean protecting capital, which is just as important as making profits. And don’t we all know that now as cash has been my major profit generator over the last 6 months while stocks flounder lower. When stocks start to pay more I’ll switch back. As to LEI’s future direction well now it has fallen out of the big sideways trading range it enters a supply controlled environment from a relatively balanced one which means rallies should be sold into until we get evidence of demand returning.
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