How markets respond to news

There are two types of financial news: the kind investors see coming and the kind they don’t. 

The former includes scheduled things like most earnings updates and interest rate decisions, which usually don’t cause a sudden shift in market prices. 

The news investors don’t see coming can send asset prices aflutter. Think out-of-the-blue headlines like CEO resignations, takeover offers, or cyber security breaches.

It’s important to understand the potential impact of news on market.

And even if you’ve no intention of actively trading the news, you’ll still need to understand why these movements are happening (or not happening): they’ll affect the value of your long-term investments regardless.

The popular “efficient markets hypothesis” proposes that market prices consider every single piece of relevant information out there. That includes not only everything that’s happened in the past, but everything investors think will happen in the future too.

Building on that hypothesis is the “random walk theory.” This suggests that if markets reflect all existing information, the only thing that can move an asset’s price is new information no one could have seen coming. 

In practice, this means markets see most significant events coming a long way off. As soon as rumors start flying, investors respond, sending the prices of assets that are likely to be affected one way or another in anticipation of the event (and the probability it comes to pass). 

By the time that event actually happens, prices will have long since shifted to reflect the news, and there’s therefore little post-event movement: it’s already been “priced in.”

Investors’ expectations are broadly priced into asset valuations well ahead of earnings or economic data being released. When updates do come out, prices are unlikely to move much if those expectations match the reality. 

When there’s an update that either overshoots or falls short of expectations, however, markets must quickly readjust – sometimes resulting in dramatic price swings. 

There’s a popular rule of thumb for trading company and macroeconomic updates: “buy the rumor, sell the fact” focuses on market sentiment rather than actual outcomes.

That might mean buying certain assets on the slightest sniff of what a forthcoming update might contain, getting in on the momentum it sets off – and then locking in any profits just before the announcement is made.

This is not a strategy that guarantees positive outcomes and is only one strategy investors may use.

There’ll always be a delay between an event occurring and the information reaching you. 

By the time you get a piece of breaking news, traders and their AI algorithmic trading programs will have already seen, interpreted, and responded to the headlines – taking any early profit opportunities and leaving you making potentially riskier bets.

But sometimes news outlets misinterpret headlines or fail to give them enough context. While short-term traders and algorithms are looking in one direction, there may be a long-term opportunity in another. And that’s why diving deeper than the headlines to understand what’s really being said in a company or macroeconomic report – and adjusting your long-term view on your investments accordingly – could be the best way to respond to market-moving news. 

Unless you’re a very active short-term trader, focusing on news flow and making decisions based on headlines and daily price moves is probably not appropriate and could magnify risks associated with attempting to time the market.

This is where having a long-term investment plan – or strategic asset allocation – is helpful. Having a plan that is based on sound principles can prevent you from making emotion-driven mistakes when markets are volatile and headlines are euphoric or gloomy.