What Is Really Going On When Markets Do The Unexpected?
It’s 8 am on the first Friday of the month.
You know the drill, you’ve experienced many Fridays like this before. You’ve done your analysis and are prepared to make a trade in half an hour’s time.
No nerves or jitters, it’s just like every other first Friday of the month.
The NFP number hits the tape. It’s a MASSIVE miss. You pile on your shorts on the SPX.
But… the market rallies. It’s now 8.35 am, the market is still rallying. You close out your trade, take the loss.
What just happened?!?!
Bad data is good!? Cue disbelief and confusion.
Most market participants, whether they’ve ever traded an NFP number or not, can probably relate with the above scenario; where the market as a whole reacts in a way completely opposite to how it should have reacted.
The emphasis here is on the word “should”, because thinking that the market should or should not react in a certain way is a product of thinking in a manner that discounts the emotions of its traders.
Clearly, if this mode of thinking is valid, then the “bad data is good?!” or “good data is bad?!” scenario cannot happen. But experience has shown that it does happen, and repeatedly too.
So, what is going on?
In general, such scenarios tend to occur when a market is trending very strongly.
This is best exemplified by strong bull markets, where traders ignore weak economic conditions to furiously bid up prices, causing them to make new record highs at a frenetic pace.
The old nugget of trading wisdom stating that markets which ignore contrary economic conditions are strong markets was written to describe precisely such a situation.
Often, these “bad data are good” market moves are rationalized by commentators who claim that markets are ignoring the economic weakness because they expect central banks to intervene with looser monetary policy.
This argument has become even more common over the last decade, especially with the onset of QE. Now, every “bad data is good” move in markets is rationalized away with “markets expect more QE”.
A good example of this is how global asset markets rallied sharply off their lows in March/April 2020, even as economies over the world faced record contractions and labor market dislocations.
All it took was massive central bank action, and the possibility of even more action. However, neither QE nor rate cuts (that is, central bank intervention) are the main drivers of these crazy moves.
Central bank action certainly affects how participants view risk taking, but the real driver of the massive, breathtaking moves especially prevalent in late stage bull markets is, believe it or not, fear.
Fear of Missing Out, more commonly known as FOMO, is what makes prices go vertical in late stage bull markets. After all, very few people can stand by and watch their neighbors quickly growing richer than them without jumping into the market with both feet.
Of course, the “good data is bad” scenario is just the opposite, where traders reject all positive data out of pure fear that prices will keep falling and conditions will not improve.
This creates massive liquidation pressure that also causes market prices to go vertical, just in a southerly direction.
Emotion, it’s a powerful thing.
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