How markets are valued: expectations, not fairness

The lesson in plain words

The same lesson as the slides above, written out in full.

1. How Markets Are Valued

Welcome. If you have ever stared at a chart and thought, this does not make sense, the news was good, so why is the market falling, then you have run into one of the most common frustrations in trading, and one of the most misunderstood ideas. Here is the key. Markets are not priced based on what is fair. They are priced based on what is expected. Once that clicks, it can change the way you read the market forever. One note before we begin. This is financial education only, not financial advice.

• Ever thought the news was good, so why is the market falling?
• It is one of the most common and misunderstood frustrations in trading.
• Markets are not priced on what is fair, but on what is expected.

A quick note: This is financial education only, not financial advice. Do not buy, sell, or hold anything based on this lesson.

2. Price Is Expectations

Let us build the idea properly. Most people assume that price simply reflects reality, the facts and the news as they stand today. But in truth, price reflects perceived future value, adjusted for risk, and modified by positioning. In other words, the market is not pricing what is happening now. It is pricing what participants collectively expect to happen next, discounted for how uncertain they are, and shaped by who already owns the stock. The market is always looking forward, through the windscreen, not the rear view mirror.

• Most people think price simply reflects reality, the news as it stands.
• In truth, price reflects perceived future value, adjusted for risk.
• It is then modified by positioning, who already owns what.
• So the market is always looking forward, not at today.

3. Consensus, Plus or Minus Surprise

Here is the formula that actually drives markets. Price equals the consensus expectation, plus or minus the surprise. The consensus, whatever the crowd already expected, is baked into the price before the news even arrives. So the movement, the thing that actually makes price jump, comes entirely from the surprise, the gap between what really happened and what was expected. This is exactly why an inflation print or an earnings report is traded against the forecast, not the raw number. A great result that everyone already expected produces no move, or even a fall, while a merely okay result that beats a gloomy forecast can send price soaring.

• A simple model: price equals the consensus expectation, plus or minus the surprise.
• The consensus is already baked in before the news arrives.
• The move comes from the surprise, the gap between reality and what was expected.
• This is exactly why a CPI or earnings number is traded against the forecast, not the raw figure.

4. Why Good News Can Fall

So this is why good news can send a stock down. If the news was good, but the market already expected it, there is no surprise, and price can drift lower as those who bought the rumour take their profits. Meanwhile, mediocre news that comes in better than a fearful forecast is a positive surprise, and price can rise on it. This is the real meaning of the old phrase, buy the rumour, sell the news. The practical lesson is to stop reading headlines at face value, and to start asking a better question every time. How does this compare to what the market already expected? Trade the surprise, not the fact.

• Good news that was already expected carries no surprise, so price can fall.
• Mediocre news that beats a gloomy forecast is a positive surprise, so price can rise.
• This is the meaning of buy the rumour, sell the news.
• Read every release as reality versus expectations, never the headline alone.