Why do stock prices change dramatically in value within seconds after release of financial results? After all, it is impossible to analyze such a large amount of information in such a short time.
In: Economics
Stock prices dont depend on factual information, a stock is worth whatever people are willing to pay for it.
And someone just needs to read a headline to want to sell all stocks they own.
Stockmarket is heavily influenced by hypes and media coverage.
Because the math has already been done in advance and the earnings are either at, better than or worse than expectations.
Most large fund and institutions have very sophisticated models used to determine the “correct” price for a stock. These models, despite the sophistication, rely on only a few core metrics. Moreover, they have the capability to do “what if” scenarios, determining what the “correct” price should be if any of those core metrics change.
So when new financial results come out, it is as simple as taking the core financial data, inputting it into the model, and seeing what the new outputs are. Modern technology can do this in seconds, giving you an updated “correct” price very, very quickly. Companies act fast on these new outputs, as buying/selling within seconds can net you significant returns.
With the initial shock out of the way, analysts will do deeper dives into the qualitative information from the reports and revise the models over the next few hours/days, resulting in adjustments to price post shock.
The investment banks and funds all have teams of analysts who spend all day evaluating these companies, their performance and future outlook, and from that estimating what the stock prices should be and what thresholds the funds should use to buy and sell stocks.
Ahead of a major earnings report they’ll have run analyses on a range of earnings values and what they think the impact on stock price will be. Those analyses are preloaded into trading algorithms ahead of the announcements and basically provide a series of IF-THEN instructions to execute immediately upon release. These algorithms can process the results and initiate trades within microseconds, allowing for almost immediate stock swings after news comes out.
A similar, albeit slightly slower and less automated, process plays out with individual traders. Everyone planning to trade on the news will have some idea where they expect the earnings to be and a plan for what to do if the results are above/below the expected – it just takes them seconds/minutes to initiate the trades.
Company A announces Sales of $1B and Net Earnings of $250M, but before that, everyone had expected Sales of $1.2B and Net Earnings of $300M.
It doesn’t take long to figure out “That’s bad”
But afterwards there are deeper dives into the earnings release that explain Sales are lower because they had to revamp production lines which resulted in delayed shipments and that the new production facilities will improve their operating margin by 25%.
Yeah, it takes a while to understand the implications of that one which may be much better overall in the long run, but in the first few moments people only care about the first head line.
A million people skimming the results and trading based on it, and then a million algorithms trading based on the pennies dropped by people because there are pricing models for derivatives and futures.
None of the comments here are talking about computers making trades. For over a decade now companies have been running automated trading systems that look at the news and act instantly when it sees positive or negative information on a stock. This is why there is so much more volume of stock trading than there was two decades ago. There is no way for an individual investor to read the news and make a trade in time to beat these systems.
Not only that, some of the computers were set up to watch active trades happening and jump in to buy stocks and resell them at a higher price as the trades were happening. There was one stock exchange founded specifically to try to prevent this.
Read the book Flash Boys by Michael Lewis. It’s a very interesting book that goes into this.
Because to make money on this sort of trading you dont just need to be right, you need to be right _quickly_.
Imagine news comes out that is bad for company A. Trader 1 sells immediately either on a gut reaction or because they have some computer setup doing a fast calculation and trading automatically. Trader two takes time to really consider all the variables in depth, which takes a day, and then decides to sell.
Trader 1 sells their stock right away for $100. Trader two has to sell their stock a day later when the price has already fallen, for $50. And so it pays to be fast.
In very simple terms there are a lot of people with their “finger on the trigger” so to speak. In reality these moves are mostly automated but everyone expects news and announcements to cause large price movements and the bulk of investors like to stay ahead of them, so they’re absolutely watching and reacting to news, with either fully automated systems taking care of it or predetermined actions that can be triggered at the push of a button of an investor watching the announcement. What’s even crazier is that these moves often happen after market hours, where the low liquidity helps exaggerate the movements.
Sec request data on files and not paper so the instant they are released they go through investor models for rating (l’ebitda, net result, net asset, indebtedness) and then the robot will decide to launch orders with price ranges to which other robots will react and within seconds the landscape could change.
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