Last Updated on September 19, 2022
News and Trading
With the availability of online news sources, including social media and trading forums, we consume a lot of irrelevant news that has no value to our trading success and may even be toxic to our minds. How important is news to trading?
As traders, we know that certain news can help us to know what is happening in the financial markets so we plan and manage our trades accordingly. Nonetheless, not all pieces of news are relevant to your trading, and consuming such news may weaken your mind, inhibit your thinking and creativity, waste your time, and generally lead to poor trading. We recommend automating your trading and using mechanical trading rules.
Let’s dive in.
News is important for asset prices
News is, of course, important in determining asset prices. Any changes in consumer prices are important for interest rates, and interest rates are important in determining the valuation of stocks.
The problem is that news is often random. We don’t know what macro numbers will be, and sometimes we don’t know when news hits.
That said, we believe it’s a rather futile exercise to follow the news. Let us explain:
How important is news to trading?
Depending on how you look at it, financial newsfeeds may or may not be useful to your trading.
On one hand, news can present you with important fundamental market information that can determine how you want to approach the market. For example, news about a change of management in a company, acquisition of a patent for an innovative product, denial of a license, a court case, or even an earnings report can affect the activities on the stock of the company concerned, and as such, affect the way you trade. Such information can help a trader decide whether to buy the stock, close an existing position on the stock, or short-sell the stock.
On the other hand, some news may only be a sort of unwanted distraction that is better ignored. Certain news doesn’t really influence the market that much and won’t have any significant effect on how a stock moves. Such news shouldn’t alter the way you trade: long or short. In some cases, even the so-called important news comes after the market has priced it in and won’t have much of an effect on the market by the time you see it. In fact, this is the case with most news that concern the markets.
Furthermore, as we wrote above, much of the news is completely random and you have no way of knowing it will happen.
Why news may not be useful to your trading
Here’s why you may not want to consume all those news:
- News is mostly irrelevant. Only a handful of news, out of the hundreds that you get every day, may be relevant to your trading. The rest of them are simply unnecessary noise that can only distract your attention without adding anything useful. Many market-related news headlines come out after the market has already priced it in. In fact, the news is often reported as a reason for a market movement that has already happened. For example, you may see headlines like, “Stock A declines after a federal court rule against….”
- News wastes time. Since most news headlines are not relevant, it is pretty much a waste of time and energy reading them. The time you spend reading news headlines could be better spent doing something more useful, such as researching a new trading edge and creating a trading strategy.
- News increases cognitive errors. Consuming much news can increase cognitive errors, such as confirmation bias. According to Warren Buffett, humans try to interpret news to suit their already-conceived opinions. It can also lead to analysis paralysis when you tend to overthink the consequences of actions you want to take.
- News inhibits thinking. Thinking requires concentration, and concentration requires uninterrupted time. With numerous news bits, your thinking is constantly interrupted, making it difficult for you to focus and come up with good solutions.
- News makes us passive. For the most part, news stories are usually about things you cannot influence. You get the news but can’t act upon it. This can make you passive, as it grinds you down until you end up with a pessimistic, desensitized, sarcastic, and fatalistic worldview.
- Frequent consumption of news may be harmful to your body. News constantly triggers the limbic system, and panicky stories spur the release of cascades of glucocorticoid (cortisol). Cortisol can deregulate your immune system and inhibits the release of growth hormones. Ultimately, your body finds itself in a state of chronic stress, which manifests as impaired digestion, nervousness, and susceptibility to infections. Other potential side-effects include fear, aggression, tunnel-vision, and desensitization.
Striking the right balance
Some news can significantly affect how a stock moves and, as such, may really be important for your trading. However, most of the news headlines are pretty useless or misleading. What you can do is filter out the irrelevant news and focus on the ones that matter. For example, if you are trading currencies, you may have to pay attention to Nonfarm Payrolls (NFP) and interest rates, and if you trade stocks, you should pay attention to earnings reports, new products/patents, and important court cases.
Backtesting and mechanical trading strategies
If you make clearly defined trading rules and strategies, you can safely ignore all news. You should focus on execution, but that is, of course, easier said than done.
Because it’s more or less impossible to ignore the news or any distractions, you are still liable to make many foolish mistakes. It’s human nature. Thus, good trading is very much about avoiding unforced errors, to borrow a term from tennis. Simply by avoiding some of the biggest mistakes, you will be ahead of most of the pack. Remember, short-term trading is practically a zero-sum game.
You should focus on backtesting and the decision-making process. What is important in trading is to make good and rational decisions based on patterns and a positive trading edge. A lot of traders focus on psychology, but the most important factor in trading is to have a statistical edge:
How can you make money with risk management and the correct mindset in trading if you don’t have an edge in the first place? This should be the first thing you think about when you wake up in the morning.
We strongly recommend reading or buying Annie Duke’s great book about correct thinking and how to make rational decisions:
Moreover, you should have a checklist for most of the things you do. There is a reason why there hardly are any accidents in the aviation industry: they use checklists to avoid unforced errors. If you read Annie Duke and Atul Gawande, you have come a long way, also in your other areas of life:
News and trading – ending remarks
It’s impossible to avoid news and certainly not to be influenced by it. Because of this, we recommend automating most of your trading – going on autopilot, so to speak. News and trading don’t mix very well, and you need to separate news unless you are a specific news trader (but that is another subject).