The phrase “priced into” has been uttered repeatedly over the past few months. If you’re new to trading you may be wondering what it actually means.
Every industry has its own lingo. Nowhere is this more apparent than in the financial markets. When it comes to trading, the phrase “Sticks and stones may break my bones but words will never hurt me” definitely does not apply.
In the financial markets, the words we use matter a lot because they dictate investor sentiment and overall behaviour. (That’s why every central bank press release is like walking on eggshells – policymakers know the words they use have a direct impact on investment outcomes.)
“priced in” or “priced into” the market is very much related to into investor psyche and understanding it will help you understand the markets much better.
Priced In: A Definition
When traders say something is priced in they simply mean a future event which is anticipated has already had an effect on an asset, because investors already expect its outcome. In other words, a stock, currency or commodity’s price has already changed based on some future event or development because traders are almost certain the event will play out a certain way.
In such cases, when the event actually happens the asset’s price does not change much, because it has already been ‘priced in’.
Other ways a ‘priced in’ asset can behave
Oddly enough, this leads us to another unique phrase: “buy the rumour, sell the fact.”
This phrase is directly tied into the previous one we discussed.
When a future event gets priced into an investment, it’s very common for that investment to move in the opposite direction once that event happens.
Sounds crazy, doesn’t it? But it happens all the time. Let’s use an example to demonstrate.
Suppose traders are almost 100% certain the Federal Reserve will raise interest rates next month. They’ve been tracking the economic data and central bank speeches in recent weeks and all seem to point to a rate hike at a certain date. With that information in hand, traders buy the U.S. dollar, sending it higher against other currencies (after all, higher interest rates usually support the dollar and weaken the appeal of other assets).
After several buying sprees, traders will conclude that a rate hike next month has already been priced into the value of the dollar. In other words, the dollar’s value is justified only on the basis that rates actually rise next month.
If the Fed actually raises interest rates as expected, the dollar may continue to rise or could go in the opposite direction. If the latter occurs, traders are said to have “bought the rumour and sold the fact.”
This reversal happens for several reasons, including overbought conditions or some other indicator that forces traders to abandon some of their initial bullishness.
So next time you read that something is “priced in” or “priced into” the market you will know exactly what it means. You will also know how this leads traders to “buy the rumour and sell the fact.”