News based trading is popular amongst retail traders. Most retail traders watch the news & based on the information which is provided to them, they take up trading positions. Retailers rush to find out the latest news about a company, commentary provided on the company by experts on news channels, ratings given by rating agencies, etc. The goal of many retail traders is to find out the latest information about a company as fast as possible so that they are the first one to enter the trade! However, most retail traders end up losing their hard-earned money due to news-based trading. But why does this happen? Why isn’t news based trading profitable?
Familiar trading scenarios – News based trading
First, let’s look at some scenarios which retail traders would have often faced during their trading journey.
Scenario 1
Today is Sunday. Company A has announced their best quarterly results of all times. The company beat all expectations & their profits rose tremendously on a YoY (year on year) and QoQ (Quarter on quarter) basis. Since the market is closed on Sunday, you decided to buy the stock as soon as the market opens on Monday. You are highly impatient on Monday to buy the stock! During the pre-opening you observe that the stock has given a gap-up opening of 3% (which means that the stock opened 3% higher compared to last day’s closing price). This further confirms your opinion that the stock is about to skyrocket soon. You buy as many shares as you can at the current market price. However, after your purchase, you find that the stock price fell! You hold the stock for the next week hoping that the news of a good result will eventually lead to a rise in your stock but unfortunately, the stock gets range bound after the initial fall. You sell your stocks after a week with a loss of almost 5-6%.
Why did you lose money in Scenario 1?
There are many reasons why the stock didn’t rise even after announcing their all time best results.
- Maybe insiders already knew about the good results & took up positions before the news came out. Then the insiders dumped the stocks as soon as the news of the good results came out! (Insider trading is illegal as per the rules from SEBI)
- Maybe the best results of the company were because of an exceptional item (1 time sale of a business/unit). Smart investors knew about the sales & figured out that the company did not perform well, they were just able to show great results due to an exceptional item! They sold their holdings & the stock fell.
- Maybe the company did perform very well but they might not be able to perform in a similar manner in the next quarter. Always remember that the stock market always looks towards the future. If the company has given out its best results, then the stock price can fall since there is nothing better to look forward to!
Whatever may be the case, you will get to know much later. By that time the stock price would have already fallen & you would have lost money by trading the news!
Scenario 2
Today is Sunday. There is a news story about a car manufacturer that the company is having some issues with the Air-conditioner duct in their latest model. The car manufacturer has announced that they will recall all of their new models sold to correct the Air-conditioner ducting problem. There is a panic amongst the shareholders about the future of the company. You are holding some shares of the company & decide to sell those shares as soon as the market opens on Monday. The stock opens at a lower circuit (let’s assume 10%)! The stock is already down 10% & you end up selling all of your stocks on Monday morning. The stock keeps on falling on Monday & you really feel good about your decision. So, you decided to take a trade by buying PUT options (going short) of the stock. However, from the next day the stock rallies & reaches much higher than the price at which you were forced to sell all your stocks. You just lost a good stock from your portfolio & you lost a lot of money because your PUT options dropped to zero!
Why did you lose money in Scenario 2?
There can be many reasons why the stock didn’t fall much after the news
- Maybe there was another news later that week that the issue is not a major issue for the company. They are easily able to repair the cars for the new model for both the existing customers & new customers. This led to a good rally in the stock.
- Maybe the new model is performing really well & despite the issue faced, the company is set to do really well in their quarterly results. The smart investors took advantage of the panic set off by the news & ended up buying the stocks at a discount.
- Maybe the issue is really a major issue but since the company’s stock was already beaten down for a long time, value investors ended up entering the stock. This led to the rally in the stock.
Whatever may be the case, you will get to know much later. By that time, the stock price increases & you lose a good stock from your portfolio as well as the option premium paid to short the stock!
Why does news based trading lead to losses?
News based trading leads to losses simply because it is not a reliable measure of the understanding of the business. A bad news might look like a minor hiccup to one investor, however the same news might be a major problem foreseen by another investor. News can often be exaggerated by media houses when they want the retail investors to take up a position in a stock. If there are fund houses ready to short a stock, they will need people to buy the stock thinking that they are getting a good deal. Remember – A trade needs both a buyer and a seller! Fund houses need retail investors to offload their bad stock.
Also, the news can be timed. If fund houses are looking to buy a stock, it is possible that the media houses will start to show all the bad news about a company. On the contrary, when the fund houses are trying to sell, the news channels will show every single positive thing about a company.
News can sometimes be a rumour which can be spread to remove weak hands from a good stock. Or it can be spread for weak hands to enter a bad stock. News which is readily available on a TV channel is common knowledge. This news can be easily used to trap retail traders! Do you think that the stock market is after you to trap you as a retail trader? To learn more, visit this article!
Is there a better way to trade?
YES! Professional traders never trade using the news. They always trade using stock charts. There are many advantages which a chart has over news which can be read in the article – Should you trade based on news or charts? News provides what big investors and traders are thinking whereas charts provide what big investors and traders are actually doing! News might be showing that the economy can be going into a recession, whereas the stock market can be booming. Stock charts contain absolutely everything which a trader needs – it contains the effect of news, it contains the effect of sentiments, it contains information about insider trading, it contains the effect of corporate announcement & it contains the effect of FII/DII positions! A stock chart contains everything, however news can often show a partial view of the real situation.
Conclusion
Many retail traders get trapped by news based trading & suffer losses. News should be treated as a noise & they should not be used to trade stocks. The stock chart provides a trader a clear view and includes all the information required for proper trading. TO learn more about a profitable trading system which investors use, visit this article! However, the final decision on whether to trade the news or charts depends entirely upon the reader!
If you liked this article, share & subscribe to this website! Follow us on Twitter!
DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
- 4 Types of Stocks which Long-Term Investors should avoid! - May 6, 2023
- Why do some companies trade at a very low P/E multiple? - November 1, 2022
- Why most investors end up buying stocks at the wrong time? - October 26, 2022
Thanks namitji. 👌👌👌