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December 1, 2003

Research and Trading

By Kris W. Tuttle

Research conclusions are making stocks more volatile. This means it is now more difficult to trade intelligently. The two major trends in the relationship between research and trading are: 1. The increased anticipation of coming events and their potential stock impact. 2. The repackaging and delivery of research specifically for traders. Indeed, research and trading are becoming much more intertwined.

With the largest stocks, there isn't much advantage in traditional research. The trading patterns and longer-term price action in stocks like GE and Cisco, for instance, have more to do with the economy, the market and investor sentiment than fundamental knowledge and analysis. However, companies in the Russell 2000 are another matter. They demand expertise in a number of areas, including research.

More than anything else, these stocks are driven by product cycles, industry factors and individual company performance. As the discounting mechanism of the market continues to improve, along with the number of research-oriented participants, changes will run their course rapidly in stock prices. At times, my approach is to anticipate an important event and document the impact of each possible scenario.

An example is a major acquisition in which the selling firm is accepting multiple bids. I recently experienced this in the Better Food and Nutrition sector. Some of the companies in my research universe were bidding, so there was a possibility one would buy the target company. But then what? My group provided an analysis of the impact at a range of purchase prices using an array of assumptions. This enabled people involved in the daily trading of the stock to be prepared when the news hit. Portfolio managers and analysts took time to understand the impact on industry positioning. But the ultimate buyer, price paid and terms would govern the stock action for the trading community.

When we cannot anticipate events, we can react quickly with conclusions based on industry expertise. The most recent example was the acquisition of SuSE Linux by Novell along with a $50 million investment from IBM. Most people knew this was "bad for Red Hat"-but how bad? Stocks reacted that day. But the benefits went only to those who knew just how deep the IBM/SuSE relationship was - and how important it would be to Novell. In fact, the deal was very bad news for Red Hat. Those who understood sold the stock aggressively rather than waiting for a bounce' the next day in response to an overreaction.' This was not a one-day downdraft. However, without a strong research conclusion in real-time, the right trade was harder to make.

Increasingly, we recognize events like these - coupled with the regular deluge of earnings reports - as the content we need to net down and put at the fingertips of the trading community.

Here is what to expect:

* More educated traders: Most traders already are organized by industry to hone their focus and build knowledge. But this progression will be followed by deeper and more fundamental analysis through direct interaction with analysts. Traders will know their industry and the stocks they trade in much greater depth.

* Sharper research focus: Research products will continue to be boiled down into content and packaging that can be placed at the fingertips of interested traders prior to and immediately after important stock events. Information will be disseminated directly to the point of trade rather than filtered down through other layers of distribution.

* Ultimately, the industry will have to solve the riddle of reward to make this model work. Today analysts who focus on helping traders are scratching their heads. That's because they often fail to drive the trading volume. Their work, however, should be valuable enough to generate productive feedback.

Kris W. Tuttle is director of research at Adams, Harkness & Hill.