The most important investing concept you won’t find explained on the internet

Evidence against the efficacy of stock picking (active management) is overwhelming (1,2,3,4,5,6,7,8,9). I’ve known that since I began investing in the 1990s. When I placed my first and only stock trade for GameStop in January 2021, it was not with the idea that I believed in the stock. I simply wanted to see what it was like to buy into a frenzy. (I’ll cut to the chase; it was terrifying.)  

You are no doubt familiar with the reddit forum WallStreetBets, which made global headlines in early 2021 when a group of mostly anonymous investors coordinated the leveraged buying of GameStop, AMC, and other stock options, pushing up the price to the point that some hedge funds lost a lot of money. It was a good David and Goliath story and a new development in consumer investing. WallStreetBets jumped in subscribed members by nearly three million accounts in 7 days as every hedge fund analyst, journalist, and day-trader joined to watch the action.

I wanted to participate somehow and I placed a single $50,000 trade on GameStop on January, 15, 2021, with the intention of selling when I either made or lost one thousand dollars. For two hours, I was glued to the screen, brain full of cortisol and adrenaline, watching my money trade in a narrow range. I almost cut my losses at $700, fearing that it would plummet beyond my $1k loss limit. Then it reversed. (Can you say Diamond hands?) I made my $1,000 and never ever want to trade individual stocks again. 

Two years before the GameStop circus, when WallStreetBets was in its infancy, one of the top posts was 'Everything is priced in', reprinted here: 

Don't even ask the question. The answer is yes, it's priced in. Think Amazon will beat the next earnings? That's already been priced in. You work at the drive thru for Mickey D's and found out that the burgers are made of human meat? Priced in. You think insiders don't already know that? The market is an all-powerful, all-encompassing being that knows the very inner workings of your subconscious before you were even born. Your very existence was priced in decades ago when the market was valuing Standard Oil's expected future earnings based on population growth that would lead to your birth, at what age you would get a car, how many times you would drive your car every week, how many times you take the bus/train, etc. Anything you can think of has already been priced in, even the things you aren't thinking of. You have no original thoughts. Your consciousness is just an illusion, a product of the omniscent market. Free will is a myth. The market sees all, knows all and will be there from the beginning of time until the end of the universe (the market has already priced in the heat death of the universe). So please, before you make a post on wsb asking whether AAPL has priced in earpods 11 sales or whatever, know that it has already been priced in and don't ask such a dumb fucking question again. 

This exaggerated but colorful post is making the assertion that markets are (at least partly) efficient, a very critical hypothesis in modern investing. An efficient market “prices in” information in the stocks, bonds, and other securities.    

But what does that really mean? I hear “priced in” on investment podcasts all the time, and it’s rarely explained. So, I googled it. And there's no Investopedia.com article on it, which is odd, because they do have a definition for the vaguely discriminatory ‘Sushi Bond’ and the interesting but trivial ‘Bowie Bond’. The Wall Street journal has a single 350 word article in its history and mostly misses the mark in explaining. 

“I’ve been researching the new iPhone and the new features are going to be so good; Apple stock has to go up,” says our friend Kate. Kate loves Apple and follows it closely. It seems like a reasonable statement on the surface.

“Priced in” means that the stock or bond has adjusted to the combined expectations of all investors. The market is full of investors that have an opinion of the next iPhone. Some think it will add profits to Apple down the line, and they buy Apple stock causing its price to go up. A few might not, and they will sell, causing its price to drop. The combination of buying and selling based on all these small predictions causes the Apple price to move to the level of the composite, market expectation.    

It doesn’t even have to be real news, the market prices in rumors and trends too. This, I think, is the important and often unexplained bit. The expectation about the next iPhone has been priced into Apple stock for years because they already have a good track record. “Priced in” means Apple stock will change on new information relative to what was expected already. If the market thinks Apple regularly delivers great new iPhones, and they do, Kate will be wrong. Her information was already “priced in” and won’t change the value of the stock. 

That’s the humor of the WallStreetBets quote. (It’s humorously coincidental that it came from the same place that the GameStop frenzy originated, an event no one priced in.) Wall Street forms these predictions long before Kate can because it’s their full-time job to focus on every detail of Apple’s production and design capacity. Even if she is an Apple fanatic, information gets to Wall Street and institutional investors long before you and me. (For the record, I dislike Apple products very much. I don’t love Android either, but I won’t own an Apple product.)   

What is the implication for Kate, who is still confident the next iPhone will be a big hit? It means she has to believe the crowd-sourced expectations of the market, which are already built in, are too low. Apple stock has to exceed the expectations of the market for Kate to profit.

Of course, she might get lucky because markets are far from perfect, and Apple stock is affected by a million pieces of information, not just the profitability of the next iPhone.

That’s not a Wall Street Bet I’m going to take. I made my thousand dollars.