$39.99 U.S./$49.99 Canada

Volatile financial markets create both the risk of substantial lossesand the opportunity for substantial gains. Sudden jumps or breaks inprices can impart a roller-coaster-ride-like quality to trading orinvesting in financial markets. Trading Catalysts is the first completeguide to the events that spark large changes in prices. These include:central bank actions; ill-advised comments by policymakers; news ofnatural disasters; elections; certain economic reports; terrorism; company specific announcements; the unwinding of large positions bykey market participants; and simple trading errors among others. Thevaried origin of trading catalysts means that some traders may havean edge in anticipating the market’s reaction to certain trading catalysts.Numerous real market examples take the reader into the heart of themarket to illustrate the direction, magnitude, speed, duration, intensityand breadth of influence of trading catalysts on market prices.Because a minute can be a “lifetime” in the world of trading, many ofthe detailed examples recount moment-by-moment and tick-by-tickchanges in market prices.

This book discusses the role that trading theses (or prevailing beliefsabout market relationships), market conditions, and sentiment play indetermining how prices react and sometimes overreact to varioustrading catalysts over time. Trading Catalysts will help readers anticipate potential events that could spark rallies or breaks; predictsituations with feedback loops that drive markets up or down; andidentify situations where substantial overreactions are likely to occur.

� Size MattersWhen key players unwind positions and move the markets

� The Information in Economic Reports: Rout or Rally?Uncertain market reaction to the forecast errors from economicreports.

� Talk Isn’t CheapWhen the comments of politicians and policymakers move markets

� Market InterventionsWhen governments intervene: case studies, from currencies to oil

� Geopolitical RiskFrom elections to terrorism to wars

� Bubbles, Crashes, Corners, and Market CrisesLessons from the “silver corner,” the 1987 stock market crash, andthe Asian Financial Crisis

� Quantifying the Market Impact of Natural DisastersFrom earthquakes to floods to mad cow disease

� Fat FingersWhen trading errors and mistranslations move the market

� Of Straws and Camels’ BacksWhen trivial news sparks huge moves

Trading CatalystsHow Events Move Markets and Create Trading Opportunities

Press

About the AuthorRobert I. Webb teaches Financial Trading at both theMcIntire School of Commerce and the Darden GraduateSchool of Business Administration at the University ofVirginia. His research focuses on derivative securities and markets, trading, and incentive economics. He is the author of Macroeconomic Information and Financial Trading (Oxford, 1994) and has written numerous academic papers.

Webb has traded treasury bonds and other fixed incomesecurities for the Investment Department of the WorldBank; traded futures as a “local” on the floor of theChicago Mercantile Exchange; designed new financialfutures and option contracts for the Chicago MercantileExchange; served in the Executive Office of the President,Office of Management and Budget during PresidentReagan’s first term; and served at the Commodity Futures Trading Commission. He previously taught at the Universityof Southern California.

Webb is editor of The Journal of Futures Markets, a leadingacademic journal on derivative securities and markets. Heearned his Ph.D. in finance from the University of Chicago,and has published widely in both academic journals and the financial press.

www.ftpress.com | An Imprint of Pearson Education

INVESTINGCover design by Solid State GraphicsCover photo by Comstock

www.ftpress.com | An Imprint of Pearson Education

Understand the Triggers of Market Volatility—and Take Advantage of Them

� Actionable lessons from 25 years of major events—and the market’s reactions to them

� Predicting the market impact of everything from Fed statements to natural disasters

� Separating real information from noise, major “market movers” from trivia

In Trading Catalysts, Robert I. Webb examines the various factors that move markets. Webb focuseson the catalysts that spark the biggest price changes—and the greatest potential for substantialprofits or losses. Using numerous real market examples, Webb demonstrates the often inconsistentresponse of prices to similar trading catalysts across markets and over time, the occasional significantly delayed response, and the frequent market overreaction.

Whether traders bet directly on a trading catalyst, on the presumed market reaction (or overreaction)to it, or not at all, the potential impact on market prices and volatility means that all traders mustpay attention to trading catalysts and the market reactions that they induce. At the very least, theprospect of significant volatility around some event may affect the timing of a trader’s entry or exitof positions and may cause a trader to reduce his position size. If you’re a serious trader, this bookwill help you understand the influence of trading catalysts and identify potential trading opportunities.

TR

AD

ING

CA

TALY

STS

WE

BB“Trading Catalysts takes you into the market and recounts moment-by-moment

price action. From an almost 14% rise in the Nasdaq following a surprise Fedrate cut to an incredible (and temporary) 22% decline in the S&P 500 futuresprice following a single large sell order, Trading Catalysts is loaded with real-lifeexamples of how events move markets. Must reading for traders and investors alike.”

—Victor Canto, Ph.D., founder of La Jolla Economics and a columnist for The National Review

“At last…an invaluable investment book that shows in detail how markets actually behaved during extreme events, times when fortunes were won or lost in the blink of an eye. This is the real world of trading and risk, not academic theory. Read, learn and prepare yourself because these types

of extraordinary events will happen again.”

—Peter Matthews, Managing Partner, Optimation Investment Management LLC

“…an invaluable investment book… This is the real world of trading and risk, not academic theory.”

—Peter Matthews, Managing Partner, Optimation Investment Management LLC

Trading Catalysts

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Trading Catalysts

How Events Move Marketsand Create Trading

Opportunities

Robert I. Webb

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Vice President, Editor-in-Chief: Tim MooreExecutive Editor: Jim Boyd Series Editor: Robert I. WebbEditorial Assistant: Pam BolandDevelopment Editor: Russ HallAssociate Editor-in-Chief and Director of Marketing: Amy NeidlingerCover Designer: Solid State GraphicsManaging Editor: Gina KanouseProject Editor: Jennifer CramerCopy Editor: Kelli BrooksIndexer: Lisa StumpfCompositor: Nonie RatcliffManufacturing Buyer: Dan Uhrig

© 2007 by Pearson Education, Inc.Publishing as FT Press

Upper Saddle River, New Jersey 07458

Financial Times Press offers excellent discounts on this book when ordered in quantity for bulk purchases or special sales. For more information, pleasecontact U.S. Corporate and Government Sales, 1-800-382-3419, corpsales@pearsontechgroup.com. For sales outside the U.S., please contact InternationalSales at international@pearsoned.com.

Company and product names mentioned herein are the trademarks or registeredtrademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by anymeans, without permission in writing from the publisher.

Printed in the United States of America

First Printing October 2006

ISBN 0-13-038556-5

Pearson Education LTD.Pearson Education Australia PTY, Limited.Pearson Education Singapore, Pte. Ltd.Pearson Education North Asia, Ltd.Pearson Education Canada, Ltd.Pearson Educatión de Mexico, S.A. de C.V.Pearson Education—JapanPearson Education Malaysia, Pte. Ltd.

Library of Congress Cataloging-in-Publication Data

Webb, Robert Ivory, 1952-

Trading catalysts : how events move markets and create trading opportunities /Robert I. Webb.

p. cm.

Includes bibliographical references.

ISBN 0-13-038556-5 (hardback : alk. paper) 1. Stock price forecasting. 2. Busi-ness cycles. 3. Speculation. I. Title.

HG4637.W43 2006

332.64’5—dc22

2006019367

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To my wife, Mary Beth, and my children,Alexander, Elizabeth, and Diana.

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CONTENTS

Preface xv

Chapter 1: Introduction 1Federal Reserve Rate Cut

Announcement 1Analyzing the Market Reaction 8The Nature of Trading Catalysts 10Do Perceived Trading Catalysts Really

Influence Market Prices? 18Trading Catalysts and Market Efficiency 21Trading Is a Game 23Trading Off of Catalysts 24References 28Endnotes 29

Chapter 2: Market Conditions and Sentiment 33Treasury Announcement Discontinuing

Issuance of 30-Year Bonds 33Market Conditions, Sentiment,and Trading Catalysts 40Treasury Announcement of Potential

Resumption of 30-Year Bond Issuance 46

Trading Lessons 54References 57Endnotes 58

Chapter 3: Talk Isn’t Cheap 61Irrational Exuberance 61Comments by Politicians and

Policymakers as Trading Catalysts 66

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Greenspan Speaks and Markets Move 69

Other Voices at the Fed 70The Asian Financial Crisis 71

Broken Promises 72Speculation or Fundamentals? 74A Trading Pattern Emerges 75Other Voices Impact the FX Market 76Speech Is Silver 77

Mr. Yen 79Lost in Translation 82Trading Lessons 83References 86Endnotes 88

Chapter 4: Geopolitical Events 91War with Iraq 91Geopolitical Events as

Trading Catalysts 100The Arrest of

Mikhail Khodorkovsky 102Elections 103

May 2004 Indian Parliamentary Election 104

The Brazilian Presidential Election of 2002 106

1992 Maastricht Treaty Referendum 1072005 European Union Constitution Referenda 108

Terrorist Actions 112September 11, 2001 114Madrid Train Bombings, March 11, 2004 117

Terror in London, July 7, 2005 119Impeachment of South Korean President

Roh Moo-hyun 120

viii CONTENTS

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Coup d’Etat: The Gorbachev Ouster 122

Trading Lessons 124References 125Endnotes 128

Chapter 5: Weather and Natural Disasters 133A Tale of Two Natural Disasters 133Natural Disasters as

Trading Catalysts 140Contamination of the Food Supply: Mad Cow Disease 141

Potential Epidemics and Pandemics: SARS 147

Weather Conditions 149Other Natural Disasters 155

Hurricane Andrew and Prepayment Speed 155

The Chicago Flood 155The San Francisco Earthquake 156

Trading Lessons 156References 158Endnotes 159

Chapter 6: Market Interventions 163A Tale of Two Market Interventions 163

Central Banks Defend the Euro 164Tapping the Strategic Petroleum Reserve 168

Market Interventions as TradingCatalysts 171Defending the Indefensible 175The Hong Kong Monetary AuthorityIntervenes in the Stock Market 180Trading Lessons 185References 187Endnotes 189

CONTENTS ix

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Chapter 7: Periodic Economic Reports 193The Trade Deficit Sparks a Bond

Market Rout 193The Trade Deficit Sparks a Bond

Market Rally 198Scheduled Economic Reports 202What Is Fundamental Economic

Information? 207Noise and Information 211Trade Selection and Trade Horizon 212Trading Lessons 217References 220Endnotes 222

Chapter 8: Size Matters 227Blood in the Water 1: Sumitomo Is Long

and Wrong 227Blood in the Water 2: The Yen Suddenly

Rises 233Internal Market Catalysts 239Order Size as a Trading Catalyst 242

Electronic Trading Games: Citigroup Hits All Bids—August 2004 243

Size Matters: March 1996 CBOT Wheat Futures 246

Trade Execution Matters 247Precursor to the 1987 Crash 249Trading Lessons 251References 253Endnotes 255

Chapter 9: Bubbles, Crashes, Corners, and Market Crises 259

The Silver Corner 260Internal Market Catalysts 271The Crash of 1987 280

x CONTENTS

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Asian Financial Crisis and Market Contagion 294

Trading Lessons 295References 297Endnotes 300

Chapter 10: The Accidental Catalyst 305The Large Cost of Small Errors 305Lost in Translation 310Dollars or Shares? 312Trading Lessons and Summary 315

Market Conditions, Sentiment, and Trading Theses 317

Trading Is a Game 319News: Information versus Noise 319The Origin of Trading Catalysts 321Extreme Events 322

References 324Endnotes 325

Index 327

CONTENTS xi

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ABOUT THE AUTHOR

Robert I. Webb is the Marvin J. Patsel, Jr., Research Professorand Director of the Center for Financial Innovation at the McIntireSchool of Commerce of the University of Virginia. He is also a visitingprofessor at the Darden Graduate School of Business Administrationat the University of Virginia where he teaches Financial Trading. Bobserves as editor for the Journal of Futures Markets—a leading aca-demic journal that specializes in publishing articles on derivativesecurities and markets. His experience includes: trading fixed incomesecurities for the Investment Department of the World Bank; tradingfinancial futures and options on the floor of the Chicago MercantileExchange; designing new financial futures and option contracts forthe Chicago Mercantile Exchange; analyzing the effects of deregulat-ing the financial services industry, among others, at the ExecutiveOffice of the President, Office of Management and Budget; andexamining issues related to international futures markets at the U.S.Commodity Futures Trading Commission. Bob has also consulted onrisk management issues for the Asian Development Bank. He for-merly taught at the Graduate School of Business at the University ofSouthern California. Bob received his M.B.A. and Ph.D. in financefrom the University of Chicago and his B.B.A. from the University ofWisconsin Eau Claire. He has written articles for a number of aca-demic journals and the financial press. Bob is the author of Macro-economic Information and Financial Trading (Blackwell, 1994).

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PREFACE

This book owes its origin to my long fascination with the behavior ofspeculative prices, in general, and extreme market moves, in particu-lar. My interest is driven by both intellectual curiosity about hownews is incorporated into market prices and fascination with thepotential for large gains or losses associated with trading aroundextreme market moves. This book is the culmination of many years ofobserving changes in financial market prices up close, as a trader, andat a distance, as a professor.

I was a doctoral student at the University of Chicago GraduateSchool of Business when the finance faculty included Fischer Black,Eugene Fama, Merton Miller, and Myron Scholes, among others;and the statistics faculty included Arnold Zellner—the brilliantBayesian econometrician. Chicago was the birthplace of the efficientmarkets hypothesis—the notion that security prices fully and cor-rectly reflect available information. However, the process by whichnew information was impounded into market prices was largely ablack box. Although I was a student at Chicago during arguably thepeak of the influence of the efficient markets hypothesis on academicresearch, the fundamental takeaway from my studies at Chicago wasnot the presumptive validity of market efficiency, or any other theoryfor that matter, but rather the importance of empiricism—that is,what do the data tell us? Indeed, the theory of market efficiency orig-inated from seemingly puzzling observations by Maurice Kendall,Holbrook Working, and Harry Roberts that changes in speculativeprices appeared to follow a random walk.

I was a newly minted Ph.D., and an assistant professor at the University of Southern California, when I watched silver and goldprices sometimes rise or fall sharply on a number of days during

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the autumn of 1979. Clearly, the movements were too large andvolatile to be explained by the arrival of new information alone, as theefficient markets hypothesis would suggest. Equally clearly, theactions of certain traders played a key role in many of the pricemoves. This episode eroded my belief in the validity of the efficientmarkets hypothesis, but increased my curiosity over how news isimpounded into speculative prices.1 It also led me to secure a two-year leave of absence from the University of Southern California andaccept an appointment at the Commodity Futures Trading Commis-sion in Washington, D.C. in 1980.

At the time, the Commodity Futures Trading Commission was arelatively new Federal Agency, having been created in 1974. Not sur-prisingly, the then-recent attempted “silver corner” was a commontopic of conversation among Commission staffers as were other issuesrelated to market surveillance. My work at the Commission gave mean opportunity to see raw news as it was reported. The Commissionhad a teletype machine that received news bulletins. The machinewas located in a hallway closet next to the water fountain. I wouldstop by several times a day to read the latest news off the wires. Iquickly recognized the important role that news editors play as Isorted through mounds of fluff for the occasional nugget of news.However, even bona fide news did not always seem to have the pre-dicted impact on market prices.

My career took a slight detour when I was offered an opportunityto serve in the Executive Office of the President, Office of Manage-ment and Budget (OMB) in 1981. My boss at OMB was Larry Kud-low. The emphasis on domestic economic policy during PresidentReagan’s first term meant that OMB was the place to be in the Rea-gan Administration at the time—until OMB Director David Stock-man was “taken to the woodshed” by the White House for someill-advised comments.

xvi PREFACE

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When my two-year leave of absence was up at USC in 1982, Ichose to enter the private sector and accepted a position as SeniorFinancial Economist at the Chicago Mercantile Exchange (CME),where I helped design new financial futures and option contracts. Itwas an exciting time to be at the CME as stock index futures contractshad only been introduced in April 1982, just months before I arrived.Working at the CME also afforded me the opportunity to observe theopen outcry system on a daily basis from the vantage point of theexchange floor. The only thing that I was precluded from doing wasentering the trading pits themselves—that was reserved for CMEmembers (i.e., seat holders) and CME pit reporters. Active days wereespecially exciting to watch and I availed myself of every opportunityto do so. Although I was closer to the market, I was not closer tounderstanding how news is impounded into market prices. I left myposition as an employee of the CME in 1983 and became a memberof the Index and Options Market division of the CME. I was insidethe “black box” at last. Finally, I hoped to get an answer to my ques-tion of how news is impounded into market prices.

An open outcry futures trading pit provides an unusually goodvantage point from which to view the determination of market pricesbecause a large fraction of total trades in an open outcry environmentare between locals. Life as a “local” was fast-paced and exciting onactive days, boring on tranquil days, but always intellectually chal-lenging. I quickly found that many of the preconceptions I had abouthow speculative prices should behave were wrong. My advancedtraining in finance was initially a disadvantage in the pit because itmade me intellectually rigid rather than flexible and open to newideas. Some intellectual baggage was discarded. At the same time, mytraining at Chicago also helped me discover many potentially prof-itable trades. I saw firsthand the wide range of factors that couldimpact market prices in the short run.

In 1986, I returned to academia when I accepted a position at theUniversity of Virginia. Almost immediately upon my arrival, I was

PREFACE xvii

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approached by the World Bank. At the conclusion of my first aca-demic year at Virginia, I took a 15-month leave of absence to work inthe Investment Department at the World Bank in May of 1987. Atthe time, the Investment Department was an active trader in fixedincome markets—trading almost as much as a primary governmentsecurities dealer. The Investment Department managed a liquidityportfolio of about $19 billion to $22 billion, depending upon whetherInternational Development Association and International FinanceCorporation funds were included. (The purpose of the liquidity port-folio is to allow the Bank to continue to perform its principal functionof lending to developing countries in the event of a financial crisis.)These monies were invested in high-grade sovereign securities. Befit-ting its status and its immense trading volume, the World Bank haddirect telephone lines to the major investment and commercialbanks. I rotated around the trading desk. My experience trading onthe floor of the CME proved to be immensely valuable when I tradedfixed income securities for the World Bank.

However, the experience of trading in the Investment Depart-ment of the World Bank also presented me with a new set of anom-alies to think about. One group of these anomalies—the oftenpuzzling reactions of fixed income prices to scheduled economicreports—inspired my book Macroeconomic Information and Finan-cial Trading (Blackwell, 1994). I was fortunate to be on the tradingfloor during the stock market crash of Monday, October 19, 1987where I observed the limited (and initially negative) reaction of theU.S. Treasury bond market to the crash. A few hours after the U.S.stock market closed, however, Treasury bonds scored their largestone-day rally ever in a delayed reaction to the stock market crash.

After my leave of absence was up, I returned to the University ofVirginia. In addition to writing articles for academic journals, I wrotea number of opinion pieces for various publications including TheWall Street Journal, the Nihon Keizai Shimbun, the Nikkei Weekly,and Investors Business Daily. In 1994, at the request of students, I

xviii PREFACE

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started teaching a course on Financial Trading at both the McIntireSchool of Commerce and the Darden Graduate School of BusinessAdministration at the University of Virginia. One of my former stu-dents, Andrew Peskin, was a particular help to me in that regard. Anumber of prominent traders, fund managers, and fund of fund man-agers have lectured to students in the course over the years includingArki Busson, John Henry, Paul Tudor Jones II, Peter Matthews,Drew Millstein, R. Jerry Parker, and Jeff Yass, among others. Thecomments of many of these speakers on the issues of the day havealso influenced my views on the behavior of speculative prices. In1998, I was appointed editor of the Journal of Futures Markets—aleading academic journal on derivative securities and markets. TheJournal of Futures Markets has had two special issues on trading dur-ing my editorship.

This book has benefited from many conversations that I have hadover the years with Hesham El-Naggar, Rick Gerson, Richard Jay-cobs, Gary Schirr, Paul Staneski, and Jules Staniewicz on a whole hostof financial topics. I would also like to thank Victor Canto andRichard Leonard for their steadfast encouragement to write thisbook. A special note of thanks is due to Jim Boyd, Executive Editor atFT Press, and to Melody Koh for her research assistance in produc-ing the various figures included in this book.

Finally, I would like to thank my wife, Mary Beth, my three children, Alexander, Elizabeth, and Diana, as well as members of myimmediate family, for the patience, love, and encouragement thatthey showed me while I was writing this book.

Robert I. Webb

Endnote1 That said, the concept of informational market efficiency is a useful benchmark

by which to measure the value of private information and assess whether thereare any hidden risks associated with potential trades. Grossly inefficient marketprices are unlikely to persist for an extended period of time.

PREFACE xix

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