Markets over-react. It’s what they do. If a trader remembers this then they can make a large amount of money. This is particularly the case with spread betting and contracts for difference.

Most people focus on over-reactions in the long and medium term, but over-reactions can occur in the very short term as well. When a piece of unexpected news arrives, either good or bad, then many traders will try to trade on that information. This can seem daunting to a trader with out the access to fast information (or the ability to constantly trade) but it can be a way of making some easy money.

Essentially the problem with the City traders is that they tend to hunt in a herd. This means that there is some easy money to be made by betting against the herd as the prices usually tend to correct quite quickly and while they are still lower or higher than they were before the news they are not as extreme as they were before.

The easiest way to remember this is that in the long term markets are close to perfectly rational, reflecting the underlying income stream and safety of an asset. In the short term they are close to perfectly irrational, going on what John Maynard Keynes called the “animal spirits”. It is the medium term where a trader makes their money.

So if there is some good news then don’t just try to buy into it, ask yourself whether the market has already overbought and, if it looks like it has, trade against it.

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