"And then all of a sudden…"

“It was all good just a week ago.”
– Jay-Z

There we were bickering over Groupon’s valuation and cheering on Apple’s latest earnings call when all of a sudden…

If traders and investors take a single thing away from the events of August 2011, it should be this:

It is not enough to know what the news is, you must also know when the news going to matter.

When markets react “all of a sudden” to news that’s been out there for a long time, there is a tendency for non-market people to throw their hands up and say “You see!  Nobody knows anything!  It’s all a game/joke/casino/farce etc!”  This reaction is understandable.

In Barry Ritholtz‘s Washington Post column this week, he looks at the mystery of why all of a sudden, things we had been aware of for months (years) all seemingly hit the fan at once this week as the Dow dropped 1000 points…

Why have markets suddenly turned so skittish? It is not as if any of the usual suspects have been unknowns. The problems in Europe were well understood; the PIIG countries (Portugal, Italy, Ireland, Greece) are just as insolvent today as they were a week, a month or a year ago. The end of QE2 was not sprung on anyone. The Fed’s liquidity program was scheduled to end June 30, a date markets knew many months ago. And no one on Wall Street really believed Congress would allow the debt ceiling to cause a U.S. default.

All of the above are after-the-fact rationales — excuses for what pundits cannot easily explain.

I know tons of worldly, knowledgeable folks who know everything there is to know about the economic news of the day – and they were murdered this week, just absolutely blown apart.  The reason is that they know What the news is, just not When that news will matter.

Earnings news matters immediately, the reaction time for a given stock can be measured in fractions of a second

Federal Reserve rate policy news matters immediately but also beforehand – there is the kneejerk reaction away from whichever direction the market was headed, then the kneejerk to the kneejerk as the accompanying statement from the FOMC is parsed, think about the crowd watching a tennis match for a reference point.

Economic news, however, is extremely tricky to game.  Sure, markets will move intraday on things like a BLS jobs release or a GDP report, but over the long haul, it is helpful to know whether you’re in a Bad News is Good environment or a Bad News is Bad environment.

In a Bad News is Good environment, the hope is that weak economic data points will mean continued accommodation from central bankers and policy makers.

In a Bad News is Bad environment, negative news begins to be treated as actually being negative – this occurs when the reality dawns on people that everything that can be done is now being done or has already been tried.

But nobody ever waves a flag saying “Okay, bad news will be treated badly from now on!”

We ignored an ominous undercurrent of negative newsflow for more than two years for the most part with only a handful of hiccups.  Europe has sucked forever as has our employment situation and it’s not like our debt pile of $14 trillion just magically appeared overnight.  So the only question is, how would an investor or a trader know that all of a sudden, these horrid ongoing news stories were going to start to matter?

The answer, as always, was in the tape and the technicals.  Jesse Livermore knew this and it took me the better part of 14 years to learn and respect this.

Old school tape-reading is a forgotten art, it is hardly taught by anyone anymore.  My friends Mike and Steve at SMB Capital know more about reading the tape than anyone else I know of, here’s their explanation of this art form:

When you read the tape you can determine whether a stock will go up or down from its present price by looking strictly at the bids, the offers, and the prints. This ability to read the next move in a stock is often absent from your charts, a lagging indicator.

This is basic supply/demand stuff – money flow.  And while it is predominantly useful to the intraday trader, the way a tape reads over a few days can send bigger signals for bigger moves.  I am admittedly, at best, a passable tape reader – I was much better at it in my brokerage days than I am now as a financial advisor as there is a different set of skills I’ve had to focus on these days. Even with my fading abilities in this area, it became apparent for a string of days that the tape had changed; bids were coming in reluctantly if at all during the last week of July and disappearing more quickly than usual.

In addition to tape-reading, a basic understanding of technicals goes a long way.  Our sell call this past Monday was informed by many economic inputs, that morning’s ISM numbers being just the latest in a series of deteriorating data points.  But the chart-wrecking 200-point plus Dow reversal was the straw that broke the camel’s back.  Sell.  The fact that all major indexes were ripping through major, longer-term support lines?  Sell even more.  I’m not a CMT or a Japanese Candlestick fetishist, but this was all right in your face so long as your face wasn’t buried in a piece of sell-side research from Merrill Lynch.

The bottom line is that being smart and informed isn’t enough.  Most of my journalist and analyst friends are brilliant, I am constantly in awe of their recall and their ability to contextualize the constant flow of information.  But having all that knowledge is far different than applying it to make (or save) money in the markets.

The ability to read the tape along with a basic understanding of technicals will help you put all that news and information you have to actual use.