Jargon is one of the main barriers to understanding financial news. These phrases take simple concepts and make them unrecognizably opaque. But if you understand the meaning behind the jargon, you can unlock insights that help you make more informed financial decisions.
One phrase that you might encounter frequently in financial commentary is “priced in.” If you understand this concept, you can more accurately digest news and information, and that can help you avoid critical investing mistakes.
What does “priced in” mean with regard to investments?
“Priced in” refers to market news that is already reflected in an investment’s price. This news could be anything that could impact its value, like an interest rate hike from the Fed, a change in leadership, an economic announcement, or anything else that could impact a stock’s value. The key here is that the event or the expected event is already reflected in the price of the investment at the time of the statement.
A piece of information is technically “priced in” when the majority of investors who plan to act based on the news have acted. However, pundits often use the term more loosely to describe a scenario where a majority of investors have considered the new information and placed their trades based on how they believe it will unfold.
Examples of Information that is Priced In
One of the key tenants of fundamental analysis is the intrinsic value calculation. While there are many ways to calculate a stock’s intrinsic value, the purpose of these calculations is to determine a fair price for the stock given the financial position of the company. Market news is one factor that plays a role in determining intrinsic value and therefore determining which trades investors place.
To illustrate, consider a company that sells appliances. Since a significant portion of buyers finance larger purchases, the company’s sales tend to decline when interest rates rise. If the Fed signals an interest rate hike next month, investors will lower their valuations of the company to account for decreased sales. Within a few days of the Fed’s signal, investors have already digested the news, adjusted their intrinsic value calculations, and traded. At this point, the news is already “priced in” although the company’s revenue has not yet declined.
Internal news can also be “priced in” prior to its official release. For example, if a company signals that their profits will be higher in a given quarter, or if other economic conditions make that factor obvious to investors, the stock price will often rise before an official earnings report is released.
How Can You Use This Concept to Profit?
One way to profit from new information relies on inefficiencies in stock markets. To understand this concept, you must first have a basic understanding of the efficient market hypothesis. This theory states that all publicly available information is immediately “priced in.” Therefore, it is impossible for a stock to be undervalued or overvalued. While the efficient market hypothesis forms the basis of many financial theories, it is not perfect in practice.
Since the stock markets are not entirely efficient, there are opportunities to take advantage of the swings that happen when news is released. Those who trade based on news are called “news traders.” Often, they trade based on the odds of a particular outcome and historical patterns of how investors have reacted to similar news in the past.
News traders sometimes adhere to the adage “buy the rumor, sell the news.” This strategy involves buying a security based on expected news, then selling it once the information is made public. This is an attempt to take advantage of inefficiencies in the market before news is “priced in.”
There are many other strategies to profit from financial news. In fact, both fundamental and technical analysis principles give a framework for responding to rumors and newly released information. However, if you don’t have the time or inclination to follow financial news and trade accordingly, partner with an experienced advisor.
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