Rajna Gibson knows a thing or two about investing and risk, advising reinsurance giant Swiss Re as a board and special committee member.

Her speech in front a public of experts invited by the Swiss National Bank was eagerly anticipated and she had some interesting advice in store: keep reading the news, because they may help you earn your living as a trader.

Overreaction to Strong Signals

This is what Gibson and her team of researchers at the Geneva Finance Research Institute have come up with: investors tend to overreact to strong signals, whereas they don’t pick up weak input at all.

In other words, they attach a much higher value to the present than the distant future and therefore have a strong urge to trade more than they ought to.

Jittery, Absurd and Confused Markets

Professor Gibson and her team developed a strategy how professional traders could make use of this link between what they coined market irrationality in the media and trading instinct.

They started out by constructing a market irrationality lexicon, a list of expressions used in the «Dow Jones» media group. It included terms such as ‘jittery’, ‘absurd’ and ‘confused’, used in stories about the economy and the markets.

Based on the number of mentions of such words – the daily market irrationality factor, which indicates a certain degree of alarm in respect to equity valuations – they looked at the behavior of stock prices in the days following such reports.

Noise Traders

«We find that reported market irrationality has a significant negative impact on subsequent stock market returns and exacerbates stock market volatility,» said Gibson in a speech held at a Swiss central bank event in Zurich. Her input was based on a study that was first published in 2015.

One of the reasons why the market reacts as it does is the presence of what the academics call ‘noise traders’. People who buy and sell securities not on the basis of what they know, but on perceived facts – some might call them alternative facts – or rumors, old and new.

Their trading behavior is strongly influenced by alarmist news and therefore trigger a volatility based on items of news reporting that may not actually reflect the true state of affairs.

Traders Take Their Time

If you now decide to take up trading based on what the media says, it may be useful to know that traders seem to take time to let the information sink in:

«We find that the market irrationality sentiment measure takes more time to impact prices than other news-based sentiment measures with the most significant impact taking place three days after its publication,» according to the study conducted by the preeminent finance professor.

Given that most people have given up on reading newspapers and that younger people are taking the news from the social media channels, Professor Gibson plans to extend her studies in a bid to find out about how markets react to news distributed by social media platforms.