Forget Buy the Rumor, Sell the News: Aug. 9, 2024

Ladies and gentlemen, hear me out. As an individual who has been trading since my teenage years, I have learned that making accurate predictions of economic data are significant for generating attractive portfolio returns. Unfortunately, the difficult task of predicting fickle investors’ reactions to new data is even more important. I’m excited to explain, however, that the newest product from IBKR, Forecast Trader, brought to you by ForecastEx, eliminates the risk of the market moving in the opposite direction of what traders expect when economic developments, such as data releases covering inflation, employment, GDP growth and other key indicators occur. Forecast Trader does this by isolating these events from externalities. The product is an interest-bearing derivative with just a one-cent fee paid collectively by both sides. The contracts allow investors to benefit simply from making correct economic forecasts, without worrying about how rates or equities will interpret the data. I have initiated positions countless times in my career expecting a hot or cold print, and while I’ve been right more times than not, technical factors, investor sentiment, the speed of the wind, the brightness of the sun or whatever turns asset prices in the opposite direction than what traders would have expected. You know the issue of is bad news good or bad? What about good news? Is it good or bad? Yeah, confusing, I know. That’s why Forecast Contracts can be quite valuable.

The expression “Buy the rumor, sell the news” is based on the trend of rumors driving the direction of sentiment, but the impact of news confirming or disputing rumors is hard to predict, especially when concurrent events may derail an expected market reaction to new data or other developments. Clearly, good news may be positive for capital markets but sometimes, good news is bad news. Unemployment data and the Consumer Price Index (CPI) illustrate this paradox. At times, a strong labor market as depicted by low unemployment supports investor sentiment because it points to a healthy economy and taller earnings, but when inflation concerns are increasing, tight hiring conditions can lead to loftier wages and stronger consumer spending, strengthening fears that escalating price pressures will cause the Federal Reserve to stymie growth by shifting to a restrictive posture. These factors can also cause what is normally considered bad news, such as a weakening job market, to be good news for investors because the economic data relieves fears of inflation and an apprehensive Fed. Similarly, benign inflation as depicted by the CPI may be favorable for sentiment because it points to modest price pressures and a central bank that is less likely to implement restrictive monetary policy. At other times, weak CPI data can point to an economic slowdown, causing investors to turn cautious and sell risk assets in response to fears of recession and contracting profit momentum.

Even if investors accurately forecast both the results of an economic release and the impact that the new data has on investor sentiment, a third wildcard, concurrent events, can derail expectations for market movements. Indeed, the influence of some of these other developments, such as corporate earnings releases, geopolitical developments, monetary policy changes or natural disasters, can outweigh the impact of expected data on investment sentiment.

The beauty of ForecastEx is that investment results are isolated from the risk of capital markets reacting differently than expected to economic events. For example, the Forecast Contract “Will the US Retail Sales growth rate be greater than 0.4% in July 2024?” with a Yes answer priced at $0.54 and the contract with a No answer costing $0.47. The one-cent fee also applies on a collective basis, as the pairing will add up to $1.01. The contract with the correct answer will pay $1, regardless of how markets react to the retail sales release or any concurrent developments. In other words, ForecastEx has eliminated what can be the trickiest part of generating superior portfolio returns-predicting fickle investors’ reactions to the release of economic indicators. 

To learn more about ForecastEx, view our Traders’ Academy video here.

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