What Is a Reaction?

In technical analysis, a reaction is a trend reversal in the movement of a security's price. Reaction is most often associated with a downward movement in the price of a security after a period of upward movement, as investors sell off shares or decrease the volume of buy orders for fear of the security being overvalued. Reactions are likely to be mild and lead to a slight increase or decrease in price, rather than a large change in value. A reaction is similar to a correction but lacks the same intensity.

Understanding Reactions

Reactions are generally considered to be positive for the overall health of the market, since unending price increases can cause inflation or result in an even larger price drop if a company doesn't meet expectations. A reaction is likely to prevent events such as runs or high volume sell offs at later dates.

When a stock has a downward reaction in price, it is often because of negative news. Negative news will often cause individuals to sell stocks. Negative news can be bad earnings reports, poor corporate governance, economic and political uncertainty, as well as unexpected, unfortunate occurrences will translate to selling pressure and a decrease in stock price.

On the other hand, positive news will normally cause individuals to buy stocks. Positive news might be good earnings reports, increased corporate governance, new products and acquisitions, as well as positive overall economic and political indicators, translate into buying pressure and an increase in stock price. For example, a hurricane making landfall may cause a drop in utility stocks. Meanwhile, depending on the severity of the storm, insurance stocks could also take a hit on the news.

Reactions and News Reports

In general, news releases result in a rapid increase in volatility, but the effect is mostly short-lived and subsides within the first minute. For example, a study on how quickly the U.S. fixed income markets incorporate new information found that a considerable portion of the changes in interest rates can be attributed to scheduled macroeconomic announcements, such as employment reports and inflation data. The major adjustment to the information released (and the window for trading profits) lasts about 40 seconds.

A study on after-trading-hours quarterly earnings announcements of 100 NYSE and 100 NASDAQ firms found that the most price reactions are realized during opening trading. Earnings announcements that occurred during trading hours caused adjustments to occur very quickly; for NYSE stocks, the price adjustment occurred during the first several post-announcement trades; for NASDAQ stocks the price adjustment was concentrated in the first post-announcement trade. Thus, U.S. markets seem to be quite efficient at processing information and incorporating that information into valuations.