Trading Lesson of the Week

• July 24, 2023

In This Week’s Issue:

• Market Outlook – Improving
• This Week’s Market Minutes video – Is the ECONOMY Going to CRASH
• Trader Training – Knowledge Can Hurt Your Stock Market Performance

Market Outlook – Improving Market

The S&P500 is trending upward nicely but the heavy weighting of tech stocks is doing most of the heavy lifting. While AAPL, AMZN, MSFT, NVDA and others are doing great, the broader market is just getting started. That means there is still good opportunities as many stocks have improving charts and are starting to show upward momentum. Technology is strong, Banking and Energy are improving.

This Week’s Market Minutes video – Is the ECONOMY Going to CRASH?

This week, I show how to use the stock market to predict the economy and how the weakness that we see today was predicted by the stock market last year. Then, I provide my analysis of the stock, commodity, and currency markets before I look at the day trade of the week on CEI.

While this email newsletter does not come out every week, I always upload the Market Minutes video for viewing Sunday morning. YouTube will alert you when it is ready to watch if you subscribe to the channel and turn notifications on.

CLICK HERE to Watch This Week's Video on YouTube

Trader Education – Knowledge Can Hurt Your Stock Market Performance

This will likely come as a surprise to many of my readers but, yes, knowing too much about the stocks that you buy can be very damaging to your performance in the stock market. I say this from experience, most of my worst trades came from knowing too much.

To understand why, you have to first understand why stock prices change. Information moves the market. A company that has an improving business and captures the interest of stock market buyers will see its stock rise in price. A negative outlook for the business by investors will send prices down.

So, information is key, which seems to conflict with my assertion that knowledge about what companies are doing will hurt your performance.

The reason is relatively simple. It is not the information that investors already have that moves stock prices. What is already known is already priced into the stock. The future movement of stock prices depends on the future flow of information to investors.

A biotech company that develops a new drug to treat a disease will see its stock price go up to reflect the success of that drug. Once the information is known by investors, there is no value to using that information since the stock price reflects what is already known. Publicly available information has no value and can actually be destructive.

The only information that is useful to an investor is that which is not publicly known. If you know that the biotech company is going to announce the successful development of their new drug in two weeks, you have the ability to buy the stock now and enjoy the gains when the rest of the market learn of this new information.

So, inside information has value. Unfortunately, trading on inside information is illegal for most people (not those in the US Congress or Senate). Still, there are many investors who act on privileged information to make decisions in the market, a fact that I will show is very important.

There are some people who can use their expertise in an industry and combine it with public information to make good guesses about what the future for a company is likely to be. These people typically work at or advise large institutional investment firms who place large investments in the stocks that they like.

The key for the rest of us is to do what the inside and large investors are doing. They have better information or expertise that gives them an advantage. If we do what they do, we can beat the stock market.

How do we know what they are doing? By watching market activity. A stock that comes alive with abnormal price gains with strong volume typically does so because motivated buyers are acting on new information that is not yet widely known.

The proof of this can be seen in the way that many stocks trade before big news announcements. Often, stocks will move up for days or weeks before big news because those with better information price in the information before it is made public.

So, we can say that publicly available information has little value (unless you have a lot of expertise) and that investors need to trade on private information or follow those that have it, but how is knowledge destructive?

Knowing too much about a company can make you attached to it. Just as new information can push a stock higher, it can also push a stock lower if the information is negative. What often happens to investors is they hold on to a stock as it moves down in price because they see no reason for it to go down because there is no publicly available information to justify the move. The selling pressure may be motivated by those who have better information and are pricing in the negative turn before most investors know what is happening.

Consider this example. You buy a stock that has a new treatment for lung cancer that has had good results in Phase 2 trials. The stock has done well and is well liked by the stock market. Despite the positive story, the stock drops 10% one day on strong volume. You choose to ignore the negative signal from the market and hang on, confident that what you know will make the stock rebound and continue higher. The next day, the stock drops about 8% and you buy more, telling yourself that you are getting the stock on sale as fools sell. This cycle of denial continues for a few more days until the company announces that their drug has been rejected by the FDA. Now the stock gaps down another 25%. You are suffering a major loss because you fell in love with the company story and ignored the market’s message.

Information is great if you have some that most people don’t. Few of us are in that position but we are all able to look at market activity and see what people are doing with their money. Trading activity never lies.