Essentially every investor in the stock market is looking for an edge – some nugget of information or wisp of insight that reveals an opportunity. The real trick is finding and exploiting this edge before it becomes common knowledge and whatever opportunity once existed has now been absorbed by the market.
A sympathy play refers to a trading strategy that hinges on how a stock responds to major news from a rival company. If a company shares significant news that boosts its stock value, such as a sterling earnings report, investors can usually expect a ripple effect on its competitors. For example, if a microchip company discloses unexpectedly high sales figures, its shares might climb. Investors might then speculate that other tech companies that either use microchips or compete in that market could similarly profit from this surge in demand.
Industries are frequently treated as one group of companies. This is due to the uniquely human tendency to organize the world in ways that make sense. The general events that benefited one company would benefit the other company. That is why sympathetic stock rises occur. But there is a blindside to this phenomenon: negative news from one company can send an entire industry down.
As trading strategies go, sympathy plays are not unique but they are more subtle than other techniques. Successful execution requires research and staying on top of the market news.
While the techniques have been deployed for years, seasoned investors and novice traders alike can take advantage of sympathy plays during market doldrums – especially when lingering fears of a recession hang like a cloud over the economy. Here’s a refresher.
How traders strategize and exploit sympathy plays:
- Monitor Sympathetic Price Shifts
Stay on top of market developments and watch for key news that might trigger sympathetic price shifts. Such news may influence not just the main company in question but also its competitors or the entire industry.
- Evaluate the News Impact
Analyze the type and significance of the news. Does it represent a major factor that could either benefit or disadvantage competing companies? Long-term implications in the news can cause sustained price changes across the industry. However, fleeting news or news without profound implications might only cause brief sympathetic price shifts.
- Pre-Identify Potential Stocks
To stay ahead of the curve, traders identify stocks that might be influenced by sympathy plays. They begin by cataloging firms in the same industry as the primary company. Investigating historical price behaviors during earnings reports can help spot trends and interconnected stock performances.
- Curate Sympathy Play Lists
Traders often create lists of stocks that exhibit sympathetic behaviors across different industries. This ensures that when pivotal news breaks, they’re equipped with a custom list of stocks to observe for possible sympathy plays, enabling them to seize emerging chances as they develop.
M&A announcements often lead to speculation about other companies in the same sector that might be looking to sell or acquire. Traders move quickly on such an investment thesis because once market sentiment sets in that a merger is possible or even probable, the share price is soon baked into the potential for a future deal.
Similarly, studying a company’s supply chain can yield potential sympathy plays. Like the old expression, “a rising tide lifts all boats,” supply chain sympathy plays are exploited around the idea that when the seller of a product – whether it be a smart phone or a box of corn flakes – reports robust sales, that means there is elevated demand for the components and materials that go into manufacturing that product. So the reasoning is these upstream suppliers are growing more profitable and their stock should rise.
Exchange Traded Funds (ETFs) can be another good source of investment ideas as the companies in an ETF are often correlated, such as by market sector. Researching and understanding these relationships can help an investor get ahead of the market. This sort of “deep in the weeds” information typically goes unreported in the business news media – and if by chance it should get reported, by then, any opportunity a stock may have presented has typically already been factored into its price as word gets around faster than putting a period at the end of this sentence.