Pricing In The Future
One of the most fascinating things about financial markets is there is always a price, as determined by simple supply and demand. Those that are selling think the market will go down and those that are buying think it will go up. And that’s the magic, the minute we settle on a price, we signal to the whole world where we think the next direction of travel will be. The price reflects all opinions, all knowledge and all future expectations for all to see.
In practice, it looks like this: If we know that on a particular day in the future something will happen that will affect the value of an investment, at what point does the price reflect the event? Think of a company takeover, an OPEC meeting or a day when the Federal Reserve will announce an interest rate change. These are all known occurrences, and in most cases, we also know the exact impact these actions will have on the value of an investment or price of an instrument.
So, let’s say you hold a stock at 50 and an announcement comes that, in 90 days there will be a stock purchase at a price of 60. When does the price adjust to the event and go higher? There are many nuances to this example, including the risk of getting paid and the financing of holding a position for 90 days in order to receive the money, but the point is this: the market puts a price on the future value immediately. At the very mention of this action, the price will go up even though it will take another three months to get the money.
It is why the quant-community (and all their glitzy machines, algos, and high mathematics) only look at the price. They don’t care about fundamental analysis, they don’t try to understand the world we live in, and they certainly don’t care about anyone's opinions. The price tells them everything they need to know, now and forever. They seem to be right, because machines have now taken over more than half of all trading models and human decision making in investment management is fast becoming an extinct species. And it’s all in the price.