The Paradox at the Heart of Today’s Stock Market
There’s a paradox at the heart of the stock market, something we highlighted in our recent post on “Money Manager Capitalism,” that deserves a deeper look.
Here’s the paradoxical truth that we need to internalize: a bad play is a good play if other investors follow your lead. If you can either set or measure trends in the stock market, you can find consistent profits whether or the analysis underlying these trends is correct.
A sample scenario makes this dynamic very clear:
A prominent analyst thinks leading indicators from suppliers suggest big sales numbers coming for a consumer tech firm. He “Upgrades” the stock, projecting it to bump up by over 10% when the next round of earnings data is released.
Two different investors see this announcement and begin to take a look at the stock in question.
The first investor is an expert on tech supply chains. His own model doesn’t show a surge in sales coming. He holds off on buying the stock. After all, he’s seen this analyst be wrong before.
The second investor spends about 20 minutes a day studying potential stock trades. She’s a knowledgeable investor, but certainly not an expert on logistics, or someone who builds her own models. But she does have a News Quantified subscription.
She has no idea whether the analyst is right about the coming earnings jump. But, looking at the data, it’s clear that this analyst has some influence: virtually all his past Upgrades on this stock all caused surges of at least 7.5% after a 1-day hold time. But she can also tell his opinions don’t have staying power: the data suggests gains tend to pull back by the 5-day mark and evaporate by the 30-day mark. She decides to buy the stock with plans to sell one day later.
Like clockwork, the analyst announcement makes waves on financial TV. The stock jumps up 8% by the end of the day, and our second investor exits her position with a handy profit.
Over a month later, earnings are released. The first investor was right all along! There was virtually no sales surge, and the stock fell 9%.
But let’s tally the score. The first investor avoided losing any money, but the second investor found a nice profit while limiting her buy-and-hold risk to a single one-day period (investors who bought waiting for the analyst’s prediction to “come true” ended up losing money after holding the stock for over a month). She profited on a trend based on an incorrect insight!
Of course, the way these trend-based dynamics play out in the real market is a bit more complex. Fund managers watch each other’s ratings. Intervening news events can shift analysts’ predictions before their past calls have time play out. Millions of individual investors read and act on these analyst opinions for themselves.
But the simple story above helps us see a logic that’s just as inexorable in the aggregate: timing a trend can be profitable even when riding the same trend is not.
This logic suggests that even the best fundamental-based traders with the most penetrating, industry-specific insights need data on trends to maximize their profits.
People like to think of the stock market as an institution that helps them understand the “true” value of a company at any point in time. But the stock market can only derive this valuation from competitive trading over the long term.
Even if prices do converge toward the point implied by fundamentals over the “long-term,” and even if an investor can interpret those fundamentals correctly, trends will still be influencing the price now—and at any future point in time. The news never stops.
That all sounds very abstract. Which is why we had to build News Quantified on a concrete reflection of all this complexity: trends are driven by news events. And we can measure the impact of news announcements not only on the day they emerge, but over time. Academic research (that actually used News Quantified’s data) suggests that news events behave the way we’d expect them to in a market dominated by trend-based investing: a single news event helps predict a stock’s price up to a quarter in advance.
That’s precisely why big institutional investors have been using similar strategies to rake in profits for decades. And precisely why we built News Quantified to help individual investors to compete.
If you’re interested in learning more about news-based investing, we’re continuing to conduct a free, live virtual training seminar series. We won’t put on a hard sell; we’ll just go over the basics of this data-driven investing strategy and take a hands-on look at how simple it can be with the News Quantified platform. You can claim a space in our next available session using the button below: