In this installment in our series of Oasis Wealth Planning’s Evidence-Based Investing Insights, we talk about Ignoring the Siren Song of Daily Market Pricing.
In our last piece, “You, the Market, and the Prices You Pay,” we explored how group intelligence governs relatively efficient markets (as well as jelly bean jars). Today, let’s look at how prices are set when news hits the airwaves. This, too, helps us understand how to play with rather than against the wisdom of the market, as you seek to make money by buying low and selling high.
News, Inglorious News
What causes market prices to change? It begins with the never-ending stream of news informing us of the good, bad, and ugly events that take place day after day. For example, when there are reports that a fungus is attacking Florida citrus trees, orange juice futures may soar, as the market predicts that there’s going to be less supply than demand. The same thing happens every day in some form for every publicly traded security.
What does this mean to you and your portfolio? The news is telling you something important, right? It sounds like you should buy, sell, or hold. Before you to take action, it’s critical to ask yourself a question: can I make money reacting to news? The answer: You cannot expect to consistently improve your outcomes by reacting to breaking news.
Why can’t we make money with an important news story? Two principles explain why our instinct doesn’t work here. Both relate to how the market adjusts its pricing.
First, it’s not the news itself that makes the price change; it’s whether the market saw it coming. When a security’s price changes, it’s not because something good or bad has happened. It’s because the news was better or worse than expected. Back to our example, if the news reports that the fungus is continuing to spread, price changes may be minimal; everyone was already expecting doom and gloom so a little more doesn’t matter much. On the other hand, if the news announces that an ingenious new fungicidal treatment is being used on the trees, prices may change dramatically in reaction to the unexpected resolution.
Thus, it’s not just news, but unexpected news that alters pricing. By definition, the unexpected is impossible to predict, as is how dramatically (or not) the market will respond to it. Once again, group intelligence gets in the way of those who believe they can outwit others by consistently forecasting future prices.
The Barn Door Principle
The second reason to consider breaking news irrelevant to your investing is what we’ll call “The Barn Door Principle.” By the time you hear the news, the market already has incorporated it into existing prices, well ahead of your ability to do anything about it. The proverbial horses have already galloped past your open trading door and the prices changed before you could get your trade submitted.
This is especially so in today’s nano-second electronic trading world. In this world of high-frequency trading and quant PhDs employed by major players, prices move fast. A number of studies among several developed markets, have shown that the universal response was nearly instantaneous price-setting during the first handful of post-announcement trades. In the U.S. markets, it was even faster than that.
In other words, unless you happen be among the very first to respond to breaking news (competing, mind you, against automated traders who often respond in fractions of milliseconds), you will be buying or selling at the post-news prices given to you by faster traders – exactly the opposite of your goal.
Rather than trying to play an expensive, time-consuming trading game based on ever-changing information and nano-second-fast competition with no guarantee of success, a preferred way to position your life savings is to accept the prices given to you by the market and, instead, focus on a number of market factors that you can better expect to manage in your favor. In future Evidence-Based Investment Insights, we’ll introduce these factors to you.
But first, let’s talk about another strategy you may be considering. If you accept that you aren’t personally up to the challenge of competing against the market, you may think you can select a pinch-hitting expert to compete for you. Next up, we’ll explore the track record of highly-qualified experts who manage investments for clients.