The Jim Cramer Effect
If you listen to CNBC long enough, you'll forget you can actually make money
Love him. Hate him. Ignore him. Every one has an opinion on Jim Cramer. Truth is, he’s trying to make a living, and found the unique niche and millions of viewers and readers that we’d all like to have. The guy’s an entertainer. He beat the market last year.
But does that mean you trade on his recommendations? No.
What spikes Jim Cramer-mentioned stocks are the thousands of viewers that follow his every word. It’s called the CNBC Effect, or, in this case, the Jim Cramer Effect.
Take a look at Wind River Systems (WIND:NASDAQ).
On January 17, 2008, Jim Cramer mentioned that Wind River Systems (WIND) was “incredibly cheap right now, trading just a quarter below its 52-week low.” It was part of the reason Cramer liked it as a possible buyout target.
On his mention alone, the stock gapped to about $9 the following day, as volume surged. But as you can see from the chart below, the Cramer-effect was short lived. Any short-term buyers following his WIND advice bought too late and lost money on the pullback to $8.
Could it eventually spike on Cramer’s buyout speculation? Sure. But what we’re proving here is that you can’t profit well from watching TV. If 400,000 people are trading on your every word, the smaller retail buyers can’t profit from the sudden spikes in prices. They’ll get eaten alive.
And when they do buy, it’s too late. The “sheep” have piled in, spiking the stock price, and turnaround, in most cases, is imminent.
On January 8, 2007, Cramer recommended a buy on Optium Corporation (OPTM:NASDAQ). The “Cramer phenomenon” spiked it to $26.50 from a $24 close, before it died off.
The same thing happened with Savient (SVNT:NASDAQ) after a January 5, 2007 recommendation. The “Cramer phenomenon” induced a gap up on extremely heavy January 8 volume. This time, the call was right. You have to give the man his kudos on that.
But oftentimes, you’re buying with thousands of other people, creating artificial volume and price spikes that may or may not last. It’s treacherous trading CNBC mentions, especially when the buy button is being hit by thousands – the same time you’re hitting the buy button.
But, can you still trade on the dissemination of news? Yes. But on a much smaller scale, like we do at Small Cap Trading Pit.
Trading on Slower News Dissemination
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
Listen, if you want to get trampled on the Cramer- and CNBC-induced buying sprees, be my guest. But it pays to trade news dissemination on a much smaller scale, or information being disseminated to a much smaller scale audience, like we do at Small Cap Trading Pit.
Ian L. Cooper
The Best Free Investment You'll Ever Make
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