How to Identify and Trade Relief Rallies

By: Wayne Duggan

Chinese e-commerce and cloud services giant Alibaba recently received a $2.8 billion fine from Chinese regulators related to antitrust violations. Coughing up $2.8 billion to the government is not something any company ever wants to do. Alibaba’s financials will certainly take a hit from the fine in the near term, but the company’s stock price had what some traders may see as a counterintuitive reaction to the news.

Alibaba’s Relief Rally
On the first day of trading after the $2.8 billion fine was announced, Alibaba shares gained more than 9%. A stock spiking following news of a nearly $3 billion fine is exactly the type of headline that might lead some inexperienced traders to throw up their hands and proclaim that the stock market is rigged. However, what Alibaba experienced is known as a “relief rally,” and it’s a perfectly reasonable response to a negative headline in certain circumstances.

A relief rally is the market’s way of acknowledging a negative headline that could have been a lot worse. No investor out there thinks Alibaba is a more valuable company without its $2.8 billion in cash. However, it’s important to put the relief rally in context to understand the trading action.

Making Sense of the Rally
Chinese regulators announced the antitrust probe into Alibaba back on December 23, 2020. At the time, Alibaba’s stock price was about $258. Since that announcement, the S&P 500 has rallied about 27%. However, before the relief rally, Alibaba’s shares had traded down to $223.31. Even after the big post-news relief rally, the stock was trading at about $243, well short of its December levels.

Sure, Alibaba stock seemingly reacted positively to bad news. In reality, it overreacted negatively to the news back in December. Alibaba shares are still down about 5.8% overall since the antitrust probe was announced. That drop is where the market is assessing the $2.8 billion in damage.

The main reason the stock rallied following the news is that the market was pricing in the possibility that the fine could be even larger than $2.8 billion.

Identifying Potential Relief Rallies
Regulatory probes, internal accounting reviews and even something as simple as a bad quarter are examples of negative catalysts that can get priced into stocks well before the details become public.

When market expectations for a stock are extremely low and uncertainty is extremely high, the table could be set for a relief rally. A stock doesn’t need good news to trigger a relief rally. Many times, it just needs the bad news to not be a worst-case scenario.

The author is long BABA.

Active Trading with Lightspeed
Lightspeed provides professional traders with all the tools required to help them find success in stock trading, and we have been developing and honing our active trader platform to offer an optimal user experience. With the intuitive interface layouts and institutional quality stock and options scanners, we aim to help traders reach their goals, no matter what their strategy is. We also offer our clients some of the lowest trading fees in the industry.

For more information on a professional trading platform with Lightspeed, please call us at 1-888-577-3123, request a demo or to open an account.

Lightspeed Financial Services Group LLC is not affiliated with these third-party market commentators/educators or service providers. Data, information, and material (“content”) are provided for informational and educational purposes only. This content neither is, nor should be construed as an offer, solicitation, or recommendation to buy or sell any securities or contracts. Any investment decisions made by the user through the use of such content is solely based on the users independent analysis taking into consideration your financial circumstances, investment objectives, and risk tolerance. Lightspeed Financial Services Group LLC does not endorse, offer nor recommend any of the services or commentary provided by any of the market commentators/educators or service providers and any information used to execute any trading strategies are solely based on the independent analysis of the user.

You may also be interested in...

The IPOX® Week, October 18th, 2021
Read More
4 Bad Habits That Stock Traders Should Break
Read More
Understanding the Difference Between Option Volume and Open Interest
Read More
The IPOX® Week, October 11th, 2021
Read More

Try the demo

Compare Platforms
Check the background of this firm on FINRA's BrokerCheck

Our website uses cookies to improve the performance of our site, to analyze the traffic to our site, and to personalize your experience of the site. You can control cookies through your browser settings. Please find more information on the cookies used on our site in our Privacy Policy. By clicking OK, you agree to allow us to collect information through cookies.

OK