In theory, information should make the stock market’s world go round. Information about companies and their ability to make money in the future is what should determine share price. As the market learns of new information, price is adjusted up and down to reflect the value of that information.
This implies that investors should focus their analysis on information. This way they can predict where share prices should go in the future.
Focusing on information makes sense… Unfortunately, however, it’s extremely rare that investors who use information consistently beat the stock market. With smaller retail investors (you and I), the use of information is often more destructive than it is beneficial.
Here are 10 reasons why we should Ignore Information and Listen to the Market:
1. Information is Usually Already Priced In
Most investors use publicly available information. Public information is widely known and available to anyone considering the stock. If information is available to a large number of investors, we should expect that the market has priced that information into the stock. Therefore, the information has no value to us.
2. Information Usually Comes with a Bias
Most people do what they are financially motivated to do. If someone is encouraging you to purchase a stock, there is a good chance they are financially motivated to do so. Before you trust the information you receive, understand the financial motivation. If you find the reason, you will often usually find that there is a strong bias in the information being provided to you.
3. Trading on Truly Insider Information is Illegal
There are few risk-free trades in the stock market, but trading on significant, inside information is one. You stand to make a lot of money buying stock in a company that will be acquired by another at a premium tomorrow. If you have that information and act on it, you are trading on inside information. This can land you in jail!
4. Gathering Good Private Information is Expensive and Time Consuming
There are investors who are able to uncover information that is not priced into a stock but is not considered inside information. This private information is valuable because it can lead to market beating returns. However, gathering private information typically requires significant resources, knowledge and time. For small investors, it is not feasible to do this kind of work across a broad range of stocks.
5. Information Causes You to Ignore the Market’s Message
When you have an understanding of a company’s story, there is a tendency to fall in love with that story and ignore new information that goes against your outlook for the stock. This leads the committed shareholder to hang on to a losing position, allowing the loser to bog down the performance of the overall portfolio.
6. You May Not Have All of the Information You Need
The market tends to focus on two or three key information points that affect the price investors are willing to pay for it. An investor who does a thorough fundamental analysis of the stock may still have an incomplete understanding of the company’s business. If missing one of the key points, this investor can make a gross error in valuing the stock.
7. The Market May Not Be Trading On Fundamentals
In theory, stock price is based on the present value of future earnings expectations. In practice, there are often very non-fundamental influences on share price. A large investor that has a liquidity crisis may be forced to unload a large position with little regard for price. Often, the laws of supply and demand affect share price even though theory tells us that they should not have an influence.
8. Your Interpretation May Not Be the Same as The Market’s
Our mood affects how we judge information and the same can be said for the market in general. Your fundamental analysis may be correct in an optimistic environment, but if the market is in a pessimistic mood, the investment can lead to losses. Even the market is wrong, it is right.
9. There Is No Standard for What Information is Worth
There are many formulas for determining what a company’s share price should. Many fundamental analysts look for stocks to trade at a certain multiple of their earnings with that multiple to be based on growth. However, there are great variations in accounting methods that can have a profound effect on how earnings are reported. More importantly, there is no rule that a company should trade at a certain multiple of earnings, that target multiple is just an opinion.
10. We Tend to Focus On Information That is Easy to Get
We often look for the easiest way to achieve a goal. With information, there is a tendency to focus on the information that is front of us. Rather than work to find something to disprove our thesis on a stock, we instead look for information to strengthen our thesis. In doing so, we present our own biased outlook for our investment decisions that can often be very incomplete and wrong.
In the end, I look at the market’s interpretation of all available information by way of the chart’s price and volume action. It shows not only every bit of information in detail but also what the market thinks of it.
Check out some of our other posts:
- What type of information will help your bottom line
- When to sell a stock, Technical vs Fundamental Approach
- The 3 Ways a Market Can Move