As a follow-up to my first post on stock market investing, where I talked about discipline. In my opinion the other most important element is expectation. This is particularly true for short-term trading but also applies to long term investing.
Let me illustrate by giving a recent example. Last week, the May unemployment number was being released. This number was hyped by a number of economic reports as well as by Obama. Let us analyze the situation of the market on Thursday. In a nutshell, the stock market had already factored in the positivity and the underlying news supporting it to this point. What comes next? The employment report at best comes out to match expectation, in which case, even if the market moves upward, the upward movement will be somewhat dampened. On the other hand, the report can disappoint in which case it will cause a serious reversal of all the factored positivity. In short, if you analyze the odds of making/loosing money due to that report its definitely not evenly distributed. It makes more sense to stay on the sidelines and watch it out, or even use options for cover in case you are long.
I have seen this same type of reaction whenever one company reports earnings ahead of a major competitor. Let us say Mastercard release very solid earnings ahead of Visa’s release. That positivity immediately spreads to Visa’s share price (pin action as JC calls it). Now what are the scenarios, again same thing: if Visa does even better, the stock will move up. If Visa disappoints it will go down (to a much bigger extent than upward movement).
In conclusion, always look out for what the expectation is. When there is too much hype be very careful about the backlash in case of disappointment. Again very simple concept yet so often missed.