Traders know that stocks tend to trade in a range until or unless there is buying or selling pressure, and nothing creates that pressure more than a catalyst. A catalyst is considered something that provokes significant change or action, which in this case, is applied to trading stocks.
So what is catalyst trading?
Catalyst trading is a way of trading that is motivated by a specific catalyst or event. Catalysts can be company, industry or market news, corporation actions, or something based off a technical indicator. Ultimately, they are a reason why you think the market will wake up to the situation — good or bad — that you see happening with the stock.
If you are considering catalyst trading, it helps to understand what kinds of catalysts identify good and bad movements in the market. Here are some examples of how to best identify trends when utilizing the idea of catalyst trading.
Catalyst trading examples
Let’s take a look at some examples of technical indicators when considering catalyst trading, starting with FireEye Inc. (FEYE). In this example, our catalyst is simply moving-average crossovers.
Check out the daily chart on FEYE.
The chart has the 20-day simple moving average crossing below both the 50-day and 200-day simple moving averages. This can be an indication of a continuation in the downtrend; it’s a catalyst for the example here.
Look at how this technical catalyst would have been important in indicating the continued selloff.
By comparison, let’s look at how company news can be a catalyst using this chart of Netflix Inc. (NFLX) as it was set to report earnings at the close on October 17, 2016. After the close, Netflix announced that it beat its earnings estimate by 100%, there was a pop after hours. Consequently, you might have jumped in looking for a sharp move higher based on this catalyst.
Here’s how the trade would have turned out.
Prior to this catalyst, NFLX couldn’t really find a clear direction for multiple months. This is another highlight of why catalyst trading is useful when looking for profitable trades.
Trading catalysts are all over, and are typically what a stock needs to find a direction and/or break out of a range. That said, practice looking for catalysts and watch how they affect stocks. Understanding catalyst trading will help you develop a clear thought process and be ready for the next time you see an event or announcement with the potential to move a stock.
Kyle Dennis runs Kyle Dennis’ Biotech Breakouts (biotechbreakouts.com). He is an event-based trader, who prefers low-priced and small-cap biotech stocks.