One of the main premises of technical analysis is the markets discount mechanism. The premise “The market discounts everything” holds that everything that can affect market price is eventually reflected in the price of that market. The price of the market reflects fundamental, psychological and political changes that underlie the supply and demand relationship.

If the fundamentals are bullish, meaning demand exceeds supply, prices will rise. If supply exceeds demand, prices will fall, and the fundamentals are bearish.

Market participants, who truly understand the above premise, are always looking ahead and anticipating all facets of the news and the events behind the headlines, in an attempt to forecast future market trends as the market responds to news. By reflecting on the history of the market, we can see that the Saudi stock market is no exception to the above premise.

I will not go far to demonstrate this; on June 7, 2006 the front page article headlines read: “CMA to Initiate New Law That Reveals Names of Persons With Illegal Stock Practices,” as a result the TASI closed down, losing 8.17 percent on that day. The rationale behind this lies in the analysis of previous events and investor perceptions.

Clearly, this was going to be another war that the CMA would lead against market makers, and this bought back memories of the July 2005 correction, where the market bottomed to 11,560/93. The July 2005 correction was sparked by authoritative measures by the CMA against strong market makers.

Another example on the market’s strong response to news came four days later. The first page of the newspaper headlines read: “King to Launch 20 projects Worth SR81 billion in Jubail,” and the market’s response was a gain of 3.15 percent on the close of Tadawul All-Share Index (TASI) that day.

The examples above justify the saying “If you want to know the impending trend, read the headlines and forget about what is inside.”

Another point that arises here is that the market rarely discounts the same event twice.

When the Custodian of the Two Holy Mosques King Fahd passed away on Aug. 1, 2005, the TASI lost more than 700 points but ended the day closing 77 points higher then the previous day’s close.

The market had sufficient time between end of May to July to discount the negative aspects of the passing away of King Fahd.

At that time, the rationale was that King Abdullah had taken over and was in full control of the situation, the economy was booming and there was in an era of prosperity and industrial development.

The price action after the king’s death resulted into two things. First, the sell-off following the news got rid of the weak holders. Second, the market taking such destabilizing news in its stride demonstrated that it was technically strong and was likely to move higher, and that is what happened.

The reaction of any market to news events can be most instructive because if the market, as reflected by price, ignores news that is supposed to be bullish and declines, it is certain that the event was well discounted, that is, already built into the price mechanism, the reaction should therefore be viewed as bearish.

If the market reacts more favorably to bad news, this in turn should be interpreted as a positive sign, demonstrating market strength.

Clearly, the market discount mechanism, is a very powerful tool that can be used to in to ways. First, it can clarify market strength or weakness by the way the market responds to news.

Second, by reflecting on news events and the way the market will most likely respond to them, you will get an idea of the next impending trend.