If an event is “priced into the market”, then it means that investors and traders already expect that event to occur.
For example, if analysts believe that a company is likely to beat earnings expectations, then it will not come as a surprise if it does. In this case, it is unlikely that the share price will skyrocket after the earnings report.
Instead, the price will probably rise in the days and weeks beforehand.
This kind of situation can lead to a lot of confusion, especially when the company’s share price falls after a good earnings report.
Bad news can also be priced in.
Take the following example.
You like Company 123 and feel that its current share price is a bargain. However, you are also aware that an upcoming legal case is likely to go against them. It might even negatively impact the company’s earnings over the next year or two.
Despite this, you still believe that the company has a bright future and that it will give you strong returns over the next 5-10 years.
As a result, you decide to invest in it.
Seven months pass by and the company loses its legal battle, just as you predicted it would.
Are you likely to sell? Of course not. Why? Because you already factored this in while you were buying your shares.
Meanwhile, other investors and traders are scratching their heads and wondering why the bad news hasn’t led to a huge drop in the share price.
They do not realize that investors such as yourself were expecting this and have already priced this event into the market.
How can you tell if other investors are already pricing something into market?
Simply put, you can’t.
Well, not with 100% accuracy.
However, there are some cases where it is “likely”.
For example, if there an important election next week and one candidate has a strong lead in the polls, then it is likely that the current market prices reflect that candidate’s victory.
In other words, analysts and investors already expect that candidate to win. Therefore, it is unlikely that the result will have a big impact the market.
Unless, of course, the polls are wrong.
Similarly, if analysts have been warning about a Fed rate hike for months, then it probably isn’t going to come as a huge shock when it does happen.
All in all, it usually boils comes down to whether or not an event is likely to occur.
Notice how I use the words “usually” and “likely” a lot here. This is because nobody really knows how the market will react to a certain event.
Analysts have been talking about a possible Fed rate hike for months now. However, when that day finally comes, it might still lead to a drop in the market.