What Is the Media Effect?
The media effect describes how certain stories that the news or media publishes may influence and/or amplify current price trends in a particular asset class, sector, or overall market. If this theory holds true, after reading a headline or article, investors or borrowers tend to be influenced by headlines and respond quickly to the news.
- The media effect refers to the influence that headlines, news stories, and social media play in influencing investor or borrower decision making.
- Stock prices can quickly move up or down upon release of a positive or negative story, respectively, presenting investors with headline risk and providing day traders opportunities to make short-term profits.
- In lending markets, borrowers respond to headlines about economic activity and interest rate changes, altering prepayment and refinancing behavior.
The Media Effect Explained
The media effect suggests that stories in the media will help or hurt a company's business and its share price. With the 24-hour news cycle and social media amplification, no company is safe from headline risk. For example, news of the Fukushima nuclear crisis, in 2011, punished stocks with any related business - even though they were far removed from the accident itself - from Australian uranium miners to U.S. nuclear power plant operators. Headlines about earnings, legal and regulatory action, or insider activity can quickly impact the share price of a company.
The media effect also operates in lending markets. Some economists attribute increases in the number of refinanced mortgages during low interest rate periods to headlines detailing a drop in interest rates and how this relates to mortgage costs. Those who read these articles are likely to increase the prepayment rates on their mortgages and refinance accordingly. Investors also observing these trends could take positions based on the immediate release of the news, anticipating the increase in refinancings.
Popular news services that many investors watch include Barron's, the Wall Street Journal, the New York Times, Bloomberg, Seeking Alpha, Quartz, and more.
The Media Effect and Trading Strategy
Many fundamental investors spend a great deal of time researching and debating whether or not to take a position in a particular security. Here, the media effect is more closely correlated with short-term trading strategies. Instead of buying and holding a particular company or asset class for a prolonged period of time, investors that adhere to the media effect could buy and sell a particular security within a one-day or one-week time period. For example, if the Wall Street Journal runs a negative story ahead of a high profile company like Tesla’s (TSLA) earnings results or prior to the rollout of a new technology update, investors could short TSLA stock.
Shorting involves borrowing company stock from a broker and immediately selling the stock at the current market price. Proceeds from this sale are credited to the short seller’s margin account. At a future time, the short seller will then cover the short position by buying it in the market and repaying the loaned stock to the broker. The difference between the sale price and the purchase price represents the short seller’s profit or loss.
For example, assume that TSLA is trading at $300 per share, and an investor believes the price will decline in the near-term as competition has increased. The investor may “borrow” shares from a broker, and sell them at the current price. When a competitor comes out with a similar energy efficient car model, and TSLA price drops to $290 as predicted, they can then purchase the shares back and return them to their broker for a $10/share gain.