Trading Tips

Some Numbers on Stock Market Earnings Reactions

I’m reading a book on trading based on company earnings announcements at the moment. I’ll post a review when I’m done, but there was something I wanted to share right away. It speaks to the question “Why didn’t the market rise on the positive news?” that comes up all the time (and which is among the questions answered in the Trading FAQs book). The book has a table in it showing how stocks have reacted to earnings surprises over I believe a 25-year period. It breaks down like this:

Positive Earnings Surprise
Market Rallies 60.55%
Market Falls 39.45%

Negative Earnings Surprise
Market Falls 61.05%
Market Rallies 38.95%

Good news isn’t always good news and bad news isn’t always bad news.

Trader Resources

Video Review: Wall Street – Money Never Sleeps

Over the weekend I finally got around to watching Wall Street – Money Never Sleeps, the sequel to Wall Street. The latter is widely considered a classic. I’m confident the sequel won’t be viewed in the same light 20 years from now, unfortunately. I’m not saying it’s a bad film in general terms. It just doesn’t live up to the original and lacks some creativity.

The thing I came away from Money Never Sleeps thinking was that it lacked the edge of the original. Shia Labeouf does not have anywhere near the same kind of screen presence as Charlie Sheen did (Bud Fox makes a brief appearance in the sequel, by the way), leaving the direct inter-personal conflicts which feature in the story – verbal as they may be – less impactful. And the lack of one strong antagonist character (Michael Douglas’s Gordon Gekko sometimes is one, sometimes isn’t) tends to diffuse the tension.

In terms of the story, if you’ve read much about the history of the financial crisis – especially On the Brink, by Hank Paulson – you will see a very strong similarity in the early parts of Money Never Sleeps. There’s also a firm that is portrayed very much in the way Goldman Sachs was portrayed in recent years. To top it all off, Gekko has very John Paulson-like success in the markets.

I do think the new film does a pretty good job reflecting how information moves around these days. Blogs, instant messaging, and the like feature along side the traditional phone and in-person interaction. Overall, though, I’d give it a middling rating. Gekko’s semi-reformed character is the only one that’s really interesting and the story is flat and somewhat disjointed.

Make sure to check out all my trading book reviews.

The Basics

The Cost of Trading

Last week I wrote a post for the Currensee blog addressing a recent SmartMoney article attacking forex trading from the perspective of costs. The article was full of misinformation of the sort I’m coming to expect from those writing about forex (and trading in general) from a journalistic point of view. I wasn’t shy about taking the author and her editor(s) to task for the piece’s short-comings.

One of the core elements of the discussion in my post was the impact of spreads on one’s trading. In the spot forex market spreads are readily visible because that’s how the market presents price feeds. In exchange-traded markets, however, spreads are often quite opaque because it’s traded prices that are the dominant presented part of prices feeds. The fact of the matter is, however, that bid/ask spreads exist in all markets.

Over the last couple days I’ve been collecting spread indications from a wide array of markets at random 15-30 minute intervals during the NYSE trading day (to ensure that all markets involved are open and active rather than including pre-market and other non-primary sessions). Here is the result of the study including some of the most actively traded market instruments.

The equity instruments were selected based on regular inclusion among the most actively traded securities (on a shares basis), so the list includes a couple of index ETFs as well has high profile individual stocks. The Treasuries list includes the current on-the-run securities, meaning the ones most recently auctioned. The futures prices are for the standard contracts except where specifically noted. Prices for the noted forex exchange rates are from the EBS dealing system. All of the above information was derived from real-time prices. (Keep in mind that markets less active than the ones presented here will tend to have wider spreads.)

The Data
I’ve a couple of primary sets of information in the above table. One is the spread. In order to standardize the comparison, I’ve expressed that in terms of the dollar value of the spread relative to a $100,000 trade. Obviously, these securities trade in a wide array of different contract and position sizes, so this isn’t meant to indicate some real-world fixed contract value. The $100,000 was just selected to make the spread values as expressed in dollar terms easy to understand and compare side-by-side. The “Avg $ Sprd/$100k” column shows what the average spread was based on about 30 intraday observations, with the “$ Sprd Rng” column indicating the range of spreads observed.

On the right side of the table I’ve incorporated broker commission estimates to provide a second set of comparative information by way of total trading cost. I’ve used $7.95 per side for the equity trades and $7.95 per round turn for the futures contracts. Brokers often will do commission-free transactions for Treasury trades, so no commission is factored in there. Similarly, zero-commisson trading is readily available for retail forex trading, so no commission is factored in there either. Obviously, the reader can replace what I’ve listed with their own numbers for a more personal comparison.

And the winner is…
If you want lowest cost trading then you want to stick to the short-term interest rate market. Spreads on 2yr and 5yr Treasury Notes are under $10 for a $100k trade, and they average under $3 for 3mo Eurodollar futures (note that this is Eurodollar, not the EUR/USD exchange rate). It’s worth noting that these are the very same markets where my volatility comparison between markets shows the lowest levels of volatility.

Beyond the short-term rates securities, the all-in cost of trading for the major forex pairs holds a modest edge over most of the other instruments included in the study. The futures markets, however, are mostly fairly close. It’s in the individual stocks where we start to see the total costs extend away from the overall group average, largely because of the broker commissions.

Market maker’s dream
Of course the one figure jumping off the page is the spread cost of Citi (C) stock. The bid/ask spread is $0.01, and the stock is (at this writing) trading below $5. That means the spread value is quite a bit higher than the same spread for the Qs trading in the $50s. Now consider that 350-400mln shares of C traded during the period of the study. That’s better than $1.7bln worth of volume. At about $205/$100,000 we’re talking about something around $3.5mln in spread differential per day!

It’s good to be a market maker in Citi shares these days!

Factoring in leverage
Note that in now way is leveraged trading factored into the figures above. They only reflect costs per $100,000 traded. That means costs as related to the value of one’s account is going to depend on how much leverage is being applied. For example, someone trading $100,000 worth of EUR/USD on a $10,000 account (10:1 leverage) will have a cost of about 0.1% ($11.10/$10,000). Similarly, someone trading $100,000 of the SPY on a $25,000 account (4:1 leverage) would have a cost of about 0.09% ($23.14/$25,000). To fairly judge the cost comparison between markets, one needs to do so on the basis of how much leverage is being applied and how frequently trades are being done.

Trader Resources

Video Interviews from the Futures & Forex Expo

While I was at the Futures & Forex Expo last month out in Vegas I did a group of short interviews with Tim Bourquin. Each focused on one question/topic related to trading. Most were forex related, but not all. 

I just received the links from the Expo folks to share the clips with you. Here they are.

What Percentage of Forex Traders Make Money?
Don’t Fear the New FX Trading Rules
A Seasonal Play Any Forex Trader Can Take
How to Find the Best Market to Trade

Enjoy. Questions and comments are welcome and encouraged.

Reader Questions Answered

What about the Forex Market?

Frequent emailer Rod is back with another worthwhile question.

Hi John,

I know you are a position trader in the stock market, using a variation of CANSLIM. You are a day trader in ES, using Market Profile. I think these are great ways to approach these markets. That’s why I would like to know how do you approach the Forex market:

– Are you a position trader? If so, do you scale-in or pyramid to build large size or do you difersify as much as possible?

– I know you use weekly Bollinger Bands and forex seasonals, but is that enough to time your entries or do you use other tools or analyses?

Thank you.


Before I talk about my forex trading, let me back fill a bit for those who haven’t followed my work. The strategy for the individual stock trading I do – which Rod correctly notes has CANSLIM as it’s foundation – can be found in an appendix to by book The Essentials of Trading. It is a strategy which combines technicals and fundamentals, and I figure on holding positions for 8 weeks when I put on a trade. The ES (mini S&P 500 futures) trading I do definitely utilizes a Market Profile approach, though I wouldn’t strictly call it day trading because I do sometimes carry positions overnight.

Now, as for forex, I do like being more of a position trader, holding trades for weeks or even months to catch good-sized trends. Sometimes I also play more swing time frame trades. Regardless of the time frame, though, my approach is basically the same. I use the Bollingers to find situations where a new trend looks likely to develop, pretty straightforward chart analysis to identify entry and exit points, and the attractor ideas from Market Profile to identify likely target points.

As for the forex seasonals, I use those to bias or filter my trading, especially the more swing oriented positions. For example, if a pair I like to trade is biased higher in September I’ll look for good long entry opportunities. I’m also planning some research into more mechanical strategies there.

In terms of scaling in and things of that nature, my history has been mixed. I’ve definitely had some times where I’ve added to positions as a trend unfolded in my direction. Other times I’ve just gone the all-in route from the start. I’m not a diversifier specifically. I do look to avoid getting overweight in any specific risk area (like being too long or short a particular currency), but because I tend to focus on one position, or at most a small number of them, at a time it really isn’t an issue very often.

Trading Tips

Penny Stocks vs. Forex Trading

Tim Sykes seems to be someone people either love or hate. He is upfront and straightforward with his opinions, which is why I asked him to contribute to the FAQs book. That doesn’t mean I always agree with him.  His 5 Reasons Penny Stock Trading Obliterates Forex Trading is a case in point.

Tim Says: The unlimited profit potential in the hugely liquid and leveraged forex market is pure marketing and deception, designed to lure the most desperate and greediest people into playing a game where the odds of success are very low similar to playing the lottery.

I won’t disagree that the marketers have a field day going after new traders by trying to hook them in on the big profit potential. The forex market does offer opportunities to small traders in ways most other markets don’t, but I definitely could do without the sales pitch I see a lot of brokers and system markets putting out there. It’s worth noting, though, that penny stocks have at least as bad a track record here, and a much longer one at that. I’m not suggesting penny stocks should be avoided. I’m just saying that both markets have been subject to some shady operators taking advantage of people.

As for the odds being similar to the lottery, that’s pure hyperbole.

Tim Says: Because Forex is so liquid and leveraged, those who succeed are the smartest, richest and most well informed people on the planet, aka George Soros and his friends.

Tim’s big point here seems to be those who attempt to manipulate the penny stock market are idiots, but the big players in forex are super smart. Tim has a strategy for trading penny stocks that works against the manipulators, and it’s one he’s had considerable success with over the years. I won’t challenge him on that part of the equation. As for forex, though, the very size and liquidity of the market makes the sort of manipulation Tim feeds on in the penny stocking world a much less workable prospect. Besides, I hold the view that an individual trader need not play in the same pool as the big boys, and can be at least as intelligent and informed where longer timeframes are concerned.

Tim Says: Forex prices move very quickly and the reaction to breaking news happens within seconds and minutes.

That’s true for any market these days, but Tim is trying to make the point that the manipulation in penny stocks which he plays off takes time to build up. I’d argue that the good trends in forex trading also take time to develop. No need to be playing in the short timeframes where news has a significant impact if one doesn’t want to do so.

Tim Says: Penny stocks are simpler. While forex prices gyrate wildly due to rumors, news and those anticipating the rumors and news, volatile penny stock chart patterns are truly straight up and then straight down with very little variation.

Hah! As if penny stocks don’t react just as wildly to rumors and news. In fact, on a straight up % change basis they move WAY more than forex rates do (see Looking at Volatility Across Markets).

Also, forex traders don’t need to worry about pattern day trader rules and have no constraints against taking short positions.

Tim Says:  Penny stocks have greater odds of success.

First, this is a meaningless statement without the figures (on both sides) to back it up. Second, as I’ve repeatedly noted, win % is only part of the performance equation, and not a determinent of it by itself. Tim mentions a 75% win rate for the types of trades he does, but I can demonstrate how even that win % doesn’t mean a winning system – and that’s not even talking about risk management.

My bottom line has always been that traders need to trade the market that suits them best. For some that will be penny stocks. For others it will be forex. I certainly have a professional interest in the foreign exchange market, but I don’t think it’s inherently better than the one for penny stocks, or vice versa.

Trading News

The Dominant Players in Forex

I see the question all the time about where prices come from in the forex market and who drives them. The answer is that it comes from the market makers in the inter-bank market. Want to know who the big players are there? Here’s the current ranking as per Euromoney (hat tip to Clint at BabyPips).

Source: Euromoney FX survey FX Poll 2009
Source: Euromoney FX survey FX Poll 2009

According to that same survey, the daily volume of forex trading breaks down like this:

  • Western Europe 50.19%
  • North America 26.98%
  • Asia 14.54%
  • All others 8.39%

Here’s something most folks probably don’t realize, however. According to a Financial Times article posted today, about two thirds of the $3.2 trillion in daily forex market transaction volume done each day is derivatives (see Most Active Forex Currency Pairs). That’s heavily in swaps. The focal point of that FT article is on the potential impact of new legislation requiring derivatives to be cleared through central clearinghouses.

It’s worth noting that the only bank in the ranking list above that does retail forex trading business is Deutsche Bank, which has the dbFX platform. The way I understand it, DB is a major liquidity provider to retail forex brokers. So the answer to the question of who is making prices in the forex market is Deutsche Bank.