It would not be news to those associated with the stock markets that stock prices are sensitive to news. Memories of May 2004 when Sensex plummeted more than 15 per cent on a single day as the tidings of the BJP debacle in the Lok Sabha elections hit the markets would be indelible in the minds of most of us.
It is not always that news has this dire an impact on the stock prices. But research in this area shows that stock prices do react to news and the volatility in stock prices does increase in periods of high news flow and volatility subsides when news flow is lesser.
Trading on news is one of the forms of trading that is followed by the agile and active traders. There are two ways to do it. The first is to ferret out any potential news that can cause a major move in the stock price. We are not talking about listening at keyholes or any other under hand activity. All it would involve is simple research that would put you ahead of the rest of the pack.
The idea is to exploit the time lag that exists between the news being disseminated to the majority. One example is to keep track of international commodity prices such as sugar, copper, steel etc. These prices percolate down to the domestic commodity markets and then the relevant stocks start moving up.
The other way to trade on news is to take position as soon as the news breaks out in the media with the hope of having the first-mover advantage. As a greater number of people come to know about the development, the stock price would move higher/lower and the subsequent move should be utilised to exit the position. Needless to say this style of trading is fraught with risks.
Exaggerated moves made by markets in response to news often get corrected in the next trading session as was witnessed after the World Trade Centre bombing. The US market and the rest of the global markets bid adieu to a long-term bear phase the day after the event occurred. It would be prudent to wait for a period of consolidation after the news-driven breakout in which to enter in to a position.