Gyration Causation

Tuesday, July 26, 2005 | 03:30 PM

Ever wonder why Markets sometimes shrug off bad news, and in other instances, seem to over-react? It’s one of the frustrating things about reading market commentary. All too frequently, attempts are made to explain day-to-day gyrations by referencing recent events. Any decent trader will tell you by the time a story hits the headlines, the impact is mostly in the stock’s price. The exceptions are purely unknown binary events (i.e., FDA approvals) or events not anticipated (such as September 11th).

As we have seen time and again, similar - even identical - causal events often produce different market responses. This happens due to many different reasons, but can help explain why similar headlines often yield a totally different market reaction.

For example, Markets are peculiarly sensitive to initial conditions. Consider event X: What came before X this time might have been different than what came before X last time. The resulting responses seem inconsistent to X, but is in fact evidence that the markets are responding to more than this single input.

That’s why trying to predict the market based upon the behavior of a single variable is so futile. Given the massive size and complexity of capital markets, it is safe to say that no one single factor can be used to accurately forecast the market consistently. Indeed, none of the recent “suspects” for market gyrations - Oil, terror, interest rates, earnings, GDP - operates in a vacuum. Not just what came before, but what is going on simultaneously with any single event can cause different outcomes. Because of this, its foolhardy to describe market doings solely on the basis of Y.

Sometimes a sell off produces nervous holders, and the net result is more sellers; other times it creates a condition of exhausted holders. When that happens, we get a selling vacuum, which sets the stage for a strong move higher.

Then, there’s the issue of collective sentiment. In the first half of the year, the markets were suffering through a malaise; It wasn’t until the late April lows that a significant shift in attitude occurred. Institutional buyers found a new want for stocks after that wash out. The net result was an increased appetite for risk as well.

These various explanations are why the markets sometimes rally while Oil is moving higher; why they shake off a terror attack, using it as a launch pad for a move up; Why Fed hikes haven’t had a particular bite yet.

Tuesday, July 26, 2005 | 03:30 PM | Permalink | Comments (2) | TrackBack (0)
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Comments

Not trying to be disingenuous, but there is only one single variable that matters: price. You can't predict with it or make forecast, but you can certainly trade with it.

Markets are essentially the same thing as weather systems. You can't say that on Friday at 11:42 am it will be 84 degrees Fahrenheit, with expected rainfall of 1.2 inches, etc. You can say that with the high pressure system moving in fast, expect an afternoon thunderstorm for tomorrow, etc. But you can't make that kind of a forecast for a date 3 years out, or even 3 weeks out. But for the next 3 days, you can have some degree of accuracy if you keep the forecast rough enough.

Same thing for the markets. You can't say that at 11:42 am EST on Friday, the S&P 500 will trade at 1257. But you can say that under certain market conditions, it is likely to head up (or down).

With weather systems, you can use satellites and weather stations' readings to make forecasts. But unfortunately for most people, such things aren't readily available in the financial markets. :-)

Posted by: John Kuran | Jul 26, 2005 5:31:04 PM

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