Some people consider news essential information for successful trading. However, other people claim that news is nothing but useless noise. So should you ever trade the news and if so, how should you do it? After reading this article, you should have a pretty good idea about the actual role of news in trading.
How Important is News Really?
There is no question about that news can be a good way to stay updated about what is going on in the world. But is it also a good way to stay updated about the financial markets? Should you ever trade the news?
My answer to these questions is: it depends. To clarify this, let me present you some of the problems that I see in financial news media:
1. Lack of objectivity
This is the case for almost all news outlets. All of them have some sort of bias and, therefore, they aren’t 100% objective. But this lack of objectivity is far worse in financial news than in normal news because often the topics presented in financial news are subjective, speculative theories. For instance, the exact reason behind a certain price move isn’t always known. Nevertheless, financial news often present their explanations as facts even though they aren’t anything than speculation.
2. There can’t be no news
Furthermore, it is important to understand that most news stations make their money from their news. This means that they always have to push out new news stories even if there isn’t anything going on. This often leads to irrelevant or even worse, made up news stories. That’s also why news stations have new news stories for even the tiniest of market moves. Most of the time, normal daily price fluctuations have nothing to do with these news stories.
There have even been cases in which the same news stations have contradicted themselves by stating that a specific news event was the cause for rising prices in the morning and the exact same news event was the reason for falling prices in the afternoon. Obviously, this doesn’t make any sense. It is very likely that there was no specific reason for these minor price swings. However, as the entire business model of news stations relies on outputting news, they can’t afford to report no news. (Even if there isn’t any real news.)
3. Backfit explanations
The vast majority of the time, news is about something that has already taken place. Therefore, news stations often add backfit explanations to past events. These backfit explanations might make a lot of sense in hindsight, but most of the time they have nothing to do with the actual event or price move.
Does this mean that news is completely useless?
No, but it means that the majority of financial news is nothing else than irrelevant noise. So my recommendation for looking at news it to focus on objective stories with actual consequences. Examples of this could be earnings announcements, Fed announcements, and similar stories. I recommend using an economic calendar and paying attention to only the most important upcoming events.
So to what extent can you really profit from news?
Once again, the answer is: it depends. The main problem with most market-impacting news is that everyone has access to it. This means that millions of people will gain access to the same information at once. Often, institutions and big investors even have access to this information beforehand. Therefore, it can be really hard to gain an edge from the news.
When Should You Trade the News?
Here are some of the few cases that I could come up with in which you might be able to successfully trade the news:
1. Long Term Impact
If major news comes out that likely will have a severe longer-term impact on an assets price, you might be able to open a position before the entire move has occurred. However, obviously, this often is a quite speculative bet.
2. Trading Through The News
One way to profit from certain financial news is to already have a position open before the news is released. By doing this, you won’t have to compete for a position right after the news comes out as you already have a position open beforehand.
However, this also comes with some disadvantages. First of all, often you might not be able to predict when news will come out and even if you know when the news will be released, it can be close to impossible to predict if the news will be positive or negative. Even for binary news events such as earnings announcements, it can be extremely difficult to predict the outcome. Not even ‘professional’ analysist and economists manage to consistently predict the earnings results of companies and the consequential stock price reactions.
Due to this, I don’t recommend trying to predict major news. The only scenario in which it can be beneficial to trade through major news is if the following is the case:
- The news has two possible outcomes: positive/negative. An example of a binary news event would be an earnings announcement in which the earnings figures either beat or miss earnings targets.
- The Risk/Reward ratio is tilted severely in your favor or you have a very favorable probability of profit.
Trying to predict news is usually a gamble, so if the odds aren’t stacked in your favor, it’s normally best to avoid news speculation.
3. Be There Before Most Others
The last tactic that can be used to profit from news is to be early. This only really works for major news that hasn’t spread yet. For instance, when a company wins a huge contract. This news might take up to a few days to completely spread. So if you are able to take a position within hours of the news release, you might be able to take advantage of all the latecomers that will push the price into a certain direction.
The problem with this is that for most well-known companies, it is almost impossible to be early. Most well-known stocks have millions of viewers all the time. Therefore, this only really works for less well-known stocks.
When a less well-known stock has new major news, it often leads to a significant price move. If you are able to catch the news early, before this major move, you can certainly make profitable trades. When doing this, make sure to pay special attention to the news. It has to have some kind of medium to longer-term impact on the company. Otherwise, it likely won’t have a big enough effect on the stock’s price.
Conclusion
I hope this article shed some light on the role of news in trading. It is much harder to gain an edge from news than you might think. Nevertheless, it is important to have some general market awareness. In other words, you should have a general idea about what is going on. You can easily get a good understanding of the overall market conditions by scanning major news headlines, using an economic calendar or simply by following major market indices such as the S&P500.
The vast majority of financial news is irrelevant noise and should, therefore, not be treated as valuable trading-relevant information. Only big economic events, earnings announcements and similar news really deserve your attention.
I don’t recommend directly trading on the news. Instead, it makes more sense to use it to get a broad idea about what is going on.
With that being said, there are some strategies that can be used to trade based on news events. But all of them have their disadvantages and risks as well. Therefore, I only recommend using the news-trading strategies presented in this article if you really know what you are doing and have a clear trading plan with implement risk management strategies for each and every trade.
Thank you for this post. I agree with you that most news stories, irrespective of what news media, is irrelevant noise. I haven’t read a newspaper or watched the news on the tv in years, because it’s too hard to sift through all the fluff and nonsensical junk to find anything actually worth taking note of. There are other ways to get the information required.
Thanks for your comment. I am happy to hear that you agree with me.
Hi Louis,
Thank you so much for sharing such an informative article with all the necessary information about how to trade the news.
In my daily life, I look at the news a lot and I agree that there is a lot of unimportant stuff on there, especially when it comes to financial news. Trading purely based on news, therefore, seems like a quite speculative and risky strategy.
Hey Louis,
Thank you for writing this informative and educative article. Your article is really unique. Newa hold a massive part in our life. As it portrays the whole world to us. But I have not read newspapers or even watched news on television for a long time because there are a lot of choas that we have to face with daily. As alternative I surf on the internet to gather informations.
Thank you so much for this helpful article.
Thanks for your comment. I agree that the internet is a great place to find relevant information. Nevertheless, there also is a lot of irrelevant noise on there as well.