Home > Articles > Business & Management > Global Business

  • Print
  • + Share This
This chapter is from the book

Do Perceived Trading Catalysts Really Influence Market Prices?

Most observers would regard a surprise Fed announcement of a targeted Fed funds rate cut as an unambiguous trading catalyst. This is not always the case for all trading catalysts. Sometimes, the trading catalyst that sparks a large move in prices may be a matter of contention. Other times, trading catalysts that have regularly sparked large price moves in the past occur without any appreciable response in market prices. An example in this regard is the inconsistent impact that large changes in crude oil prices have on the equity market.

Trading catalysts that spark large and sudden changes in market prices are more readily identified than trading catalysts that spark small changes. However, sometimes trading catalysts spark small changes in market prices immediately but accumulate to a large change over time. This category of trading catalyst may also have an effect on market prices by reinforcing market sentiment and thereby help create the conditions for a more abrupt change in prices later.

There is a natural human tendency to impose order on apparent chaos. This tendency applies to attempts to explain financial market behavior as well. This is especially true for large price changes. Intuition suggests that there must be a reason for a large price change. Most of the time there is. For instance, few observers would dispute that news of the Federal Reserve rate cut sparked a rally in equity prices on January 3, 2001. However, sometimes large price changes occur for no apparent reason. This occurs more frequently than one might think. During 2000 and 2001, there were a number of instances where the Dow Jones Industrial Average or the Nasdaq Composite changed by 3% or more from the previous trading day. Yet, there is no readily identifiable source for many of these price moves. These large price moves may be the result of internal trading catalysts discussed in Chapter 8, "Size Matters," and Chapter 9, "Bubbles, Crashes, Corners, and Market Crises."

The lack of a readily identifiable source for many large price changes may explain the sometimes seemingly inconsistent behavior of market prices in response to certain trading catalysts over time. It may also explain how seemingly innocuous events can precipitate large price changes.

The preceding discussion assumes that there is only a single trading catalyst affecting the market at a given moment in time. It is possible that there may be several competing trading catalysts of which the news media only highlights one or two. Multiple trading catalysts could reinforce or offset one another. This may also explain apparent inconsistencies in the impact of the same trading catalyst on market prices over time. Isolating the individual market impact of multiple conflicting trading catalysts would likely be difficult. In any event, perhaps more important than the potential existence of multiple trading catalysts is whether most traders perceive (correctly or incorrectly) that trading activity is being driven by a single trading catalyst.

The question naturally arises as to whether the attribution by journalists of a large price move to a given trading catalyst is accurate. After all, journalists are expected to provide their readers, viewers, or listeners with informative explanations of what prompted a market move. Are the explanations in media accounts accurate descriptions of the causes of price moves, or are the reported catalysts simply rationalizations or excuses traders use for doing what they intended to do all along? There are two aspects to this question. First, is the reported trading catalyst the correct reason for the price action? Second, if so, what fraction of the price move is explained by the presumed trading catalyst?

To be sure, news media stories typically try to account for the price action of the entire trading day rather than focus on the immediate reaction to the trading catalyst. In addition, news media accounts of the impetus of a given price change may also be biased by the choice of whom the media interviews or obtains its information from. In any event, it is often impossible to determine the fraction of a market's reaction that can be attributed to a given trading catalyst. That said, contemporary news media accounts of the apparent causes for large changes in prices, although not perfect, provide a good summary of the perceived causes of large price changes during the day.

If the reported causes of large price moves are simply rationalizations by traders for doing what they already intended to do, the market-moving power comes not from the arrival of the trading catalyst but from the acquisition, hedging, or unwinding of trading positions and the trading they induce. Although it is possible to "explain" virtually any price change, it is worth noting that the puzzling behavior of financial prices is not confined to cases with ambiguous trading catalysts. As the opening example in this chapter demonstrates, the behavior of financial market prices in response to unambiguous trading catalysts is also sometimes puzzling. Moreover, there are numerous examples of puzzling market reactions to various trading catalysts that will be discussed in this book.

  • + Share This
  • 🔖 Save To Your Account