I love the movie Finding Nemo, but my favorite part is when they give the main character the nickname “sharkbait”, mostly because my kids think it’s hilarious to hear them say “shark bait oo ha ha!” But what is shark bait in the world of finance? And who are the sharks?
The financial markets are made up of two distinct groups — the retail investors and the professional institutional investors. The retail investors are those investing in their IRA’s, 401K’s, 403B’s and so on. This money makes up a significant portion of the money in the markets on a daily basis, even if these investors are not actively trading and investing. These retail investors are typically always bullishly biased and only taking the action to buy. The professional investors are made up of the banks, insurance companies, hedge funds, etc. Knowing this, we have to ask ourselves the question “who are the sharks in the story”? Obviously the sharks are the professional investors, and the shark bait are the retail investors who often times fall victim to the professionals, especially in the short term. There are many buy and sell signals presented in the financial markets every day, inviting investors to take action to either buy or sell. One of these actions presents an opportunity, and the other represents a trap. To become a more sophisticated investor is to learn to spot these traps.
One way that the retail investors and traders fall victim to the professionals is falling for news-driven trading traps. Most retail investors have heard the phrase “buy the rumor and sell the news”, but what does that truly mean? One thing to notice is that there are 2 inherent flaws just with that saying alone. The first flaw is the buying of the rumor, as if the retail public will have some early insight before the professionals. One thing to consider is that by the time the retail public hears a rumor, the professionals have probably already heard this rumor and acted upon it. The second flaw in the “buy the rumor and sell the news” phrase is the inherent bullish bias in the phrase. The phrase alone implies that investors only make money by buying and then realize those gains by selling. Retail investors and traders are typically only positioned long (they only make money in a rising market) while professional investors and institutional investors are positioned long/short (they make money in both directions) to give them a distinct advantage. Look at the below chart to notice a key problem with traditional thinking.
In the chart above we are looking at the TLT, an ETF which represents the 20-yr Treasury Notes. This ETF is an easy way for investors to participate in US Bond market movements. Notice the purple circle in the lower right. The purple circle represents the day the Fed announced a rise in interest rates, which should correspond to a drop in bond prices. The rise in rates was announced on March 15th and has had the exact opposite effect since that point, with the TLT up over 5% from that time. Notice also that the circled area occurred exactly in a spot where Demand had exceeded supply in the past, which is highlighted in yellow. I have written in the past that Demand and Supply is the only thing you need to concern yourself with in financial markets, as in general it will trump news releases. So who was selling the TLT at these price levels and who was buying? The answer to that should be obvious; professionals were buying and retail investors and traders were selling. This is 100% contrary to what has been taught to most retail investors, specifically to sell bonds when rates rise. Also, if you consider the phrase “buy the rumor and sell the news”, this also contributed to the losses of the retail investor.
This is just one example of professionals laying traps for retail investors and finding an opportunity to use them as shark bait and to fall victim to common market traps. Over time most retail investors and traders never reach 100% of their financial goals. That is, because without even realizing it they have been trained and conditioned to do this backwards.
Chuck Fulkerson is the Director of Student Development at Online Trading Academy, a leader in investing and trading education for any market or asset class. Fulkerson helps education individuals across the globe in what it means to be a successful investor and trader. He currently trades options as a swing and position trader; futures and currencies as a day trader; and equities as an investor to round out a truly diversified trading portfolio.
Read Next
