How Stocks Act Around Major Sector Catalysts
One of the most important concepts for new traders to learn is that foreseeable sector catalysts impact related stocks ahead of the actual materialization of the catalyst in question.
In other words, once something is obviously going to be impactful, the market starts to “discount” or “price in” the phenomenon in question well ahead of it actually happening.
A useful example is what we just saw in the Marijuana and Cannabis stocks during the Fall of 2016 as a large number of states voted to further legalize pot in election voting.
Buy the Rumor…
It became obvious as of midway through the Summer that something big was brewing. By that time, we already knew that at least five different states, and maybe as many as nine, were going to be carrying ballot measures on the November 8 election ballots pertaining to various levels of further legalization of Pot in those respective states.
Perhaps most importantly, California was among them, with a looming proposition set to determine possible full recreational legality for Pot in the state.
Anyone who has spent time in California knew that there was at least a “very good” chance that this would pass. And, passage of just this one state’s bill, according to some analysts, could as much as triple the US market for pot.
Do you think the stocks were going to wait for November 8th to decide whether or not to rally on this catalyst?
Sell the News…
Not a chance. In fact, the positive result in 8 of 9 states was the signal to take profits because so much money had front run this news that the important next phase of the game was to convert the thesis back into cash in the bank. Hence, we saw the other part of the game: “Sell the News”.
The key take-away is this: If you can tell that something big is coming, then it’s likely that others can, too.
At that point, the game changes from figuring out that some identifiable future moment is going to possibly be a driving catalyst to figuring out how much of a bet to make on it ahead of time. As different players in the market play this game, those bets compete with each other, drawing the impact of the catalyst ever further forward in time.
This continues to play out until the confidence level of all interested players, as an aggregate, is expressed in an auction-like result. That outcome creates a market pricing of the potential meaning of the catalyst.
Once that reality is in place, if it then transpires that the market has been acting on correct assumptions (ie, if people generally thought the votes would pass, and then they did), then the actual manifestation of the news can only result in profit-taking.
As a case in point, look at any of the most widely traded cannabis plays (TRTC, CANN, CNAB, MCOA, CBDS, etc). You will quickly see that almost all of them topped on or around the November 9 “victory day” for the catalyst. The was the first time that traders and investors who bought these stocks anticipating this outcome would have had a chance to conclude that any and all knee-jerk reaction buying resulting from the positive vote outcome had a chance to run its course.
Hence, since the bets in play were not long-term investments in the companies, but bets on the outcome of the vote, it was time to harvest the cash created by the process.
We have seen most of these stocks fall by 20-50% since the vote, as should be expected according to this important object lesson in market behavior.