I don’t like talking about profits. I like making them.

I use a lot of technical and fundamental indicators to spot explosive small caps. One of my favorites has been the use of news dissemination. But it’s not our only indicator. We have ten maxims for trading small caps.

It wasn’t until I left my PR position in 1999 that I realized I could use the news dissemination process to make money on Wall Street.

Sure, even I’ve heard the theories on trading on the news. I’ve read Eugene Fama’s 1973 Efficient Market Hypothesis, which says that when news is released, it is immediately reflected in the price of stocks. In other words, he felt that markets efficiently and instantaneously process new information.

Why Eugene Fama Was Dead Wrong

Not all news is baked into the market and accounted for. I’ve disproved that theory countless times. I’ve taken my bumps and bruises discounting the efficient market theory, but I disproved its validity, as did Evans and Lyon’s report in the Journal of International Money and Finance (2004):

“The market could still be absorbing or reacting to news releases hours, if not days, after they are released. The study found that the effect on returns generally occurs in the first or second day, but the impact does seem to linger until the fourth day.”

Why Trading on the News Works

You see, what allows us to trade on news is information friction, or the delay in the dissemination of news to a greater number of investors through electronic media. Sometimes the news or rumor we pick up on won’t be fully disseminated, meaning that the intended audience won’t get it until later in the day when they get home from work. By then, we’ve already bought the stock and are just waiting for the trigger (the nightly news report, for example) that’ll throw gasoline on our small flame.

But the question remains, can the average investor really profit from news without having proprietary research?

Yep.

As a study from the Harvard Institute of Economic Research observes, “New technology is rapidly democratizing securities markets. The costs of gathering information and executing trades are being driven to negligible levels. These changes allow a rapidly growing base of investors to participate in the financial system.”

And there are dozens of high-level studies to support my news-driven investment approach.

“I examine returns to a subset of stocks after public news about them is released. I compare them to other stocks with similar monthly returns, but no identifiable public news. There is a major difference between return patterns for the two sets. I find evidence of post-news drift, which supports the idea that investors under-react to information [ . . . ] There is a large amount of evidence that stock prices are predictable.”
--Wesley S. Chan, M.I.T., Stock Price Reaction to New and No-News: Drift and Reversal after Headlines

“Arguably, the most important process affecting price movements is the news arrival process. For example, in Ross (1989) the volatility of stock price changes is directly related to the rate of flow of information to the market [ . . . ] On days no news arrives, trading is slow and price movements are small. When new information arrives that results in a change in expectations, trading becomes vigorous and the price moves in response to the impact of the news [ . . . ] In addition to price movements, news arrivals can affect the time between trades, number of transactions, and volume of trade.”
--John H. Maheu, University of Alberta, and Thomas H. McCurdy, University of Toronto, News Arrival, Jump Dynamics and Volatility Components for Individual Stock Returns

“Periods of good news are followed by periods of unusually high returns relative to natural benchmarks, with the reverse for bad news [ . . . ] Post-event drift is the tendency of individual stocks’ performances following major corporate news events to persist for long periods in the same direction as the return over a short window--usually one to three days--encompassing the news announcement itself.”
--Andrew Jackson and Timothy Johnson, Unifying Under-reaction Anomalies

So the next time some one says you can’t trade on news, laugh in their face.

Trading on the News: A Mental Note

Please note, trading on news alone is a dangerous, highly volatile blood sport. It’s the reason it’s not the sole trading apparatus in SCTradingPit.com.

When we’re not trading news, we trade volume spikes, undervalued gems, earnings growth, the undiscovered, the forgotten, the ignored, the ones with little or no analyst coverage, momentum, blood in the streets, technical set-ups and candlestick patterns.

We’re not your average run-of-the-mill small cap letter. We’re not looking for paltry gains of 10%. We’re looking for the next Yahoo, eBay, and Wal-Mart.

If you can’t handle those profit possibilities, I understand.

But for those that want to make good money, SCTradingPit.com launches shortly.

Ian L. Cooper
http://www.wealthdaily.com