Stock prices change as new information becomes available. It’s not surprising that many investors believe that it is crucial to follow financial news carefully and then act quickly on news that might be relevant to their investments. While this may sound like a good idea, the reality is that you cannot expect to consistently improve your investment outcomes by reacting to breaking news. Here are three reasons why:
First, it’s not the news itself; it’s whether you saw it coming. When a security’s price changes, it’s not whether something good or bad has happened; but rather, it’s whether the next piece of good or bad news is better or worse than expected. Thus, it’s not just news, but unexpected news that alters the price. By definition, the unexpected is impossible to predict, as is the magnitude of the market response.
Second, 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. This is especially true in today’s micro-second electronic trading world. Unless you happen to be among the very first to respond to breaking news (competing against automated traders who often respond in fractions of milliseconds), you’re setting yourself up to buy high and sell low, exactly the opposite of your goal.
Third, even if you had first access to new information, it’s not always clear what it means. One day the news comes out that unemployment is lower than expected, which is good news for stocks. But lower unemployment may lead to an interest rate hike sooner than expected, which could be bad news for stocks. Or maybe it’s neither good news nor bad news; maybe it’s just noise. While the media likes to tell a story that sounds good, the real world of changing market prices is extremely complex. An honest headline might read something like this: “The market was up (down) today and we have no idea why.”
So rather than trying to play an expensive game based on ever-changing information, cut-throat competition, and imperfect knowledge, it’s usually best to not react to breaking news. In fact, you don’t even need to watch it. Instead, build a portfolio that is likely to produce a good outcome for you over time regardless of what happens on CNBC.