Why news is already in the price
By the time a news item reaches you, professionals have long since processed it. Only the surprising part can be traded, and you don't see it in time.
Learning objective: After this lesson you can explain why known news is usually already in the price.
Important announcements are processed in seconds, often by programs that analyze the text automatically and trade immediately. By the time you read about it, the move has happened.
Why news arrives too late
So if you buy straight after good news, you usually buy at a price that already includes the news. You're paying for information that no longer is any.
On the stock market people say: buy the rumour, sell the fact. That's exactly the process behind it. The expectation drives the price, and when the event then happens, there's nothing left to drive it further.
What follows for you
The conclusion is a relief. You don't need to follow the news to invest successfully. The feeling of always having to be well informed costs many people time and nerves and doesn't improve their results.
Studies of scheduled announcements such as quarterly results show that most of the price reaction happens within seconds to minutes. How strongly the price reacts depends on how far the figures differ from analysts' estimates. How good the figures are on their own plays a smaller role.
Evidence from earnings reports
However, a drift after surprising earnings is also documented. The adjustment then continues for a few weeks. That doesn't quite fit the theory of fully efficient markets. But the effect is small compared with trading costs and can only be used at all with a large, broadly diversified system following fixed rules.
Drift after surprises
For you this isn't an opportunity to trade, but it says something about your position. Getting news faster isn't an edge you can have. Your possible edge is a longer investment horizon than many others in the market. Many professionals are measured every quarter and have to look good in the short term. You can sit out swings for years, and that's a real edge you have as a private investor.
Summary
- The price adjusts to an announcement in seconds.
- Following the news doesn't improve your results.
- One real edge you have is that you can wait longer.
Did you get it?
How quickly do markets process scheduled announcements?
Most of the adjustment happens within seconds to minutes.
What does buy the rumour, sell the fact mean?
The expectation drives the price. When the event happens, there's nothing left to drive it further.
What is a private investor's real edge?
That they can wait longer and sit out swings for years.
Check your understanding
Your task
Think of a news item from the past twelve months that made you want to trade. Write two sentences on how long the news had already been out when you saw it and what exactly you wanted to do. Then note what would have changed in your long term result if you had done nothing.
Sources and further reading
- In their 1968 study in the Journal of Accounting Research, Ball and Brown first showed that stock prices keep moving in the direction of the surprise for weeks after an earnings announcement, an effect since known as post-earnings-announcement drift. View source ↗
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