Whether it’s a new regulation set to cripple an industry or a breakthrough product that could send company profits sky-high, you’d expect breaking news to move markets and present investment opportunities aplenty. And it does – just not always in the way you’d think.
What does that mean? There are two types of financial news: the kind investors see coming and the kind they don’t. And both influence market prices in very different ways.
It’s the latter that probably sticks in the mind: those genuinely out-of-the-blue headlines which set prices all aflutter. Think of sudden resignations from CEOs, scandals leaked to the press, and breaches in cybersecurity – events like these can cause markets to plummet or soar in the blink of an eye.
Then there are those stories any investor worth their salt knows are coming: earnings updates, interest rate decisions, and so on. News like this doesn’t always cause a sudden shift in market prices. But that’s not because it’s not important. It’s just because financial markets are cleverer than you might think…
This is where things can get a little complicated, but bear with us. In this Pack, we’ll help you understand why stocks, bonds, and the like change when the headlines do – or, sometimes more importantly, why they don’t.
Why should I care? Because the news has a massive impact on markets. Even if you have no interest in trading on the market movements caused by breaking stories, you need to at least understand why those movements are happening (or, er, not happening). They’re sure to affect your investments one way or the other, after all.
If you are thinking of actively trading the news, you could be onto something. It’s a decent strategy many investors swear by – though as you’ll see later on, you’re up against some stiff competition. So grab your newspaper, turn on the TV, and steel yourself for the mania of the newsroom. First up – why does some news not affect some asset values?
The takeaway: There are two kinds of news – expected and unexpected – and they both affect markets in different ways.
Efficient markets & "pricing in"
Since the 1960s, a theory known as the “efficient market hypothesis” has been hugely popular in financial circles. Simply put, it states that market prices take into account all the information that’s already out in the world. That doesn’t just include all the things that have happened: it includes all the things investors think might happen too.
Following on from that hypothesis, there’s also the random walk theory. It states that if markets reflect all existing information, the only thing that should be able to move the price of a stock is new information no one saw coming. So according to both these theories, news doesn’t just move stock and bond prices – it’s the only thing that can move them.
What does that mean in practice? It means the markets see the most significant events coming. Sure, totally unexpected news still has the power to upset market prices – take BP’s 2010 oil spill, which led the oil giant’s stock to lose half its value. But most news isn’t nearly this unexpected.
Whether it’s the next blockbuster from Disney or disappointing manufacturing data from the Federal Reserve (Fed), investors are pretty good at spotting market-moving events from a long way off. As soon as rumors start flying, the price in question will start to move one way or the other in anticipation of the event. And as it becomes more or less likely, it’ll have an even greater sway. So by the time that event actually takes place, the price will already long since have shifted to reflect the news.
Take Apple as an example. Say there are whispers it’s about to announce a new brain-implant gadget – one investors think could really catch buyers’ imaginations (not to mention whatever else they have in their heads). They start buying Apple stock in anticipation, driving the price up. And as more and more rumors about the gadget start to swirl and the hype continues to build, Apple’s share price climbs even higher...
So when Apple actually announces the device (with its usual panache, of course), its stock price… barely moves. That’s because investors were expecting the announcement to happen, and all the gains were made before the official news came out. In other words, the event had been “priced in”.
The takeaway: Most news is priced in ahead of the market-moving event itself, which is why you might not see much of a bump on news day.
How earnings updates affect prices
What happens to stocks ahead of earnings updates? As we mentioned in the last session, markets generally know market-moving news is going to happen before it actually does. And that’s especially true of company earnings updates – the time of year when a firm announces how much money it made in the last few months.
That’s because banks and investment firms around the world hire big teams of analysts to crunch the numbers and try to calculate (read: guess) what those earnings will look like ahead of time. So they’ll look at growth metrics and market research data, and they’ll sometimes speak to customers and suppliers to get a picture of how the company’s faring.
That data gets plugged into a complicated financial model to create a forecast, which is then aggregated with everyone else’s into a consensus. When you hear someone talk about what “the market” expects, this consensus is what they’re referring to. Analysts also try to work out what the company’s “earnings guidance” will be: that’s the information put out by a company telling investors what to expect in the next earnings report.
All these expectations then get priced into the stock’s value well ahead of earnings actually being released. If earnings are expected to indicate growth, the stock will probably tick up; if not, it’ll likely go down. And then, when earnings day comes around, the company’s stock price might not move much because these expectations are simply being met – just like in our Apple example last session.
What about when the update doesn’t match up to expectations? When a company announces an “earnings surprise” – an update that either overshoots or falls short of expectations – the markets do what markets do best and adjust to the news. But because this happens all of a sudden, the swing in one direction or the other can be dramatic – though some evidence suggests companies are punished more for missing expectations than rewarded for beating them. Turns out investors aren’t the most forgiving folks.
How can I trade earnings? Clearly, analysts aren’t always right – and if you think they’ve missed a trick, you can take advantage. So if, for example, you reckon they’ve underestimated a stock’s potential, you could buy it up before the earnings announcement and hopefully benefit from an uplift. But that’s a big gamble: can you really analyze a company better than the people with more data, technical expertise, and people power than you can shake a stick at?
If the answer’s yes, you have a bright future in front of you. If not, your best bet might be thinking further ahead than analysts do. They tend to have a pretty narrow interest in what’s going on in the here and now, because that’s what their clients are focused on. By thinking further into the future, you might discover certain opportunities that won’t come good in the short term – but might in years to come.
The takeaway: Earnings tend to be pretty well forecast by big teams of investment analysts – but even those experts aren’t always right.
How interest rate decisions move markets
Central banks like the Fed are the puppet masters that pull the economy’s strings. And there’s one thing they look after with a particularly dramatic effect on the markets: interest rates.
It’s up to the central bank’s committee whether to raise or lower rates – a decision that increases or reduces the cost of borrowing money respectively and makes growth easier or more difficult for companies. Just as with a company’s earnings, their decision is announced at a regular update. But (and stop us if you’ve heard this one before) stocks don’t wait until the actual announcement to start moving.
Well in advance of any actual decision, traders scrutinize each and every word bank officials use in an effort to predict what’s coming. And fairly quickly, a consensus starts to develop in the investing world. You might’ve heard, for example, investors talk about how “obvious” it is that the Fed’s going to cut rates next month. And that consensus then causes the markets to move one way or the other.
But central bank decisions are much harder to predict than company earnings. That’s because they’re made by committees of people with individual opinions, and there’s no hard data on what they’re actually thinking just before a decision is made.
Sure, it’s not in their interests to keep investors completely in the dark – that would make markets skittish. So the Fed does try to indicate which way the committee is leaning. And investors generally know which members of the committee are hawkish (i.e. favor high-interest rates) and which are dovish (favor low rates). But even so, nothing scares an investor quite like a lack of hard data to read into 👻
So how can I trade these decisions? There’s a popular strategy for trading central bank decisions: buy the rumor, sell the fact. That means buying up stocks as soon as whispers of a rate cut first start circulating, getting in on the rally it sets off – and selling up just before the decision is actually announced.
So rather than trading on the actual outcome of the decision, you’re trading on market sentiment instead. Sure, you might miss out on some extra gains if the rate cut does go ahead. But you’ve also locked in your profit if the rumors turn out to be false. And if rates are raised, you’ll be in a prime position to buy back in after stock prices fall.
So far we’ve covered what makes trading the news popular among investors. But if you’re going to become one of them, you’ll need to know the challenges you’re facing too. That’s up next.
The takeaway: Central bank decisions can be harder to predict than earnings updates, and some savvy investors won’t even try to.
Can you beat the market?
“buy the rumor, sell the fact” – is built on the principle that even anticipated news isn’t a sure thing. So is unexpected news any better?
probably not. After all, there’s a delay between the time an event occurs and the time it takes to reach you. So by the time you hear breaking news – even if you have CNBC switched on 24/7 – it might as well be called the old.
Think about it. Journalists need time to verify the story, package it up for the right channels, and get it out into the world. And even then, it’ll probably take you another minute or so to log in to your brokerage account and buy or sell the shares. So let’s say it takes an optimistic 10 minutes to go from the release of the news to the execution of your trade ⏱
In the world of modern finance, 10 minutes is an eternity. Because when you’re trading, you’re not just competing against other individuals like you: you’re up against gigantic financial institutions.
What do professional traders have that I don’t? Quite a lot, actually. In fact, they’re basically playing a completely different ballgame. You might have to wait for news to appear on your phone, but they don’t: it’s sent to them the second it’s published via (very pricey*) wire services like* Reuters. And while you need to read an article to decide how you’re going to trade, the pros do nothing of the sort. Sophisticated AI algorithms can now read all the news for them and trade based on the news – instantly.
So even when there’s unexpected news, you’ll be hard-pressed to take advantage: the stock price will already have adjusted by the time you hear about it, let alone respond.
Should I not bother, then? According to Tyler Tebbs broker at Olivetree Financial, sometimes news outlets misinterpret stories or don’t give enough context to them. So while traders are looking in one direction, the story might actually be happening in another. Algorithms are smart, but they’re programmed to respond to the whims of the wider market. And if you spot something everyone else is missing, you might be able to pull a Sarah Connor and get one over on the robots.
So if there’s one thing to keep in mind, it’s this: when you trade on the news, you’re often just trading on how investors respond to the news. That means it’s up to you – not The Guardian, The New York Times, or Bloomberg – to decide whether a bandwagon is worth hopping onto or not. Dive deeper than a top-level glance at the headlines, and be smart about what the company, central bank, or whoever is really saying. Because if you’ve got a nose for the news, you’ll be able to sniff out opportunities everyone will wish they picked up.