A lot of traders have been utterly confounded by the way things have been playing out in the markets lately. In particuarly, I have seen numerous questions as to why better than expected economic data – like last week’s Q3 US GDP reading – is actually seeing the dollar get sold off rather than bought. The question these traders and investors have is “Why is good news not good for the dollar?”
First of all, I’ll repeat what I’ve said many, many times now:
In the current market cycle, good economic news is bad for the dollar.
Why? The main reason is that there’s still a strong risk aversion or flight to quality element in the markets. By that I mean market players are still skittish about things and prone to quickly move from “risky” markets to low risk ones if they get bad news. That’s why you will often see US Treasury Bonds rallying in conjuction with the dollar, at the same time as commodities are being sold along with stocks.
Makes sense, right? Traders and investors will move out of markets which are more inclined to perform well in good economic conditions than bad. That money then goes somewhere safer, like Treasuries, which of course are denominated in dollars.
That brings me to my main point, though.
It’s the movement of money, not economic data or news, that drives prices.
People get WAY too wrapped up in the economic releases. Big money action – the real driver of sustained price moves – is not reacting to a GDP figure which is probably going to be revised anyway, and has some warts when you look closely.
Do the markets react to data? Yes, they do, but it’s more about the data giving the market an excuse to do what it’s already inclined to do anyway. That’s why strong bull markets often trade positively on good news but more or less ignore bad stuff, and the other way around for bear markets. This is why it’s a good idea to watch how the markets react to news and data, because it can tip you off to potential changes in market sentiment.
Those already max long cannot buy more.
Also keep in mind that traders are to a greater or lesser degree constrained by the positions they already hold. If a portfolio manager is already as long IBM as he wants to be or is permitted within the fund’s guidelines, he isn’t going to buy anymore of it no matter how good the earnings news. At that point he can only be a seller of stock.Â
Now imagine a large portion of the market already as long as it wants to be or can be and you’ll understand why sometimes markets react negatively to positive news. That’s the underlying reason for the “buy the rumor, sell the news” market reactions.
So if you’re not planning on being a purely mechanical technical trader and/or want to understand why the market is doing what its doing, I strongly recommend that you learn to read the price action in relation to data, news, and cross-market analysis to understand where the money is and where it’s going.
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
** See John’s full bio.
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