Try this Test

Amar Pandit , CFA , CFP

You have a piece of information based on which you have formed your opinion on where the market is headed.

Let us take the example of the recent US President Elections in November 2020. Many People were so confident that markets would fall and were willing to make changes to the portfolio in response to the elections. Taxes did not matter and the fact they could be wrong did not matter. The Headlines screamed corrections and people thought they should sell.

I was talking to a friend at that point of time, and he was so confident about the markets crashing. He was going to make changes to his portfolio based on this noise.

I asked him to run his information based on which he was making the decision (on public stock markets) through a test. I have reproduced it below for your usage.

  1. Is this private confidential insider information? He said No.
  2. Are you the only person to know this information? He said No.
  3. Do you think the market has not factored this already even if it were true? He did not have an answer.

The stock market is a forward-looking machine, and it looks several quarters ahead. If you think something is important, chances are others would have too and the information would have been factored into the markets already.

Yes, markets react to certain news, but these movements are normally short lived, and some are as short as a few days.

Now what would have happened if you answered Yes to the first 2 questions.

If the answer to the first question was Yes, it means it is insider information and it is illegal to act on it anyway. So that is out of the way. The second question then has no meaning.

You also cannot answer “Yes” to the second question even if you answered “No” to the first question. If it is not insider information, how can you know that you are the only person to know this. It is simply not possible to answer Yes to the second question unless you know for sure this is known in a closed circle. If you answer Yes to this question, it means that this is privileged insider information that cannot be used legally.

I hope I am not making this too confusing.

Many investors think they are the only ones to know things. If you think you know what is going to happen in 2024, chances are others know it too.

The point is that if the information is already widely known, why have the markets not reacted yet. The real answer is that maybe it knows something that you do not.

Understanding this reality is a key element of successful investing.