If you ever feel like you’re suffering from information overload when you are trading, don’t worry – so is everyone else.
And according to research conducted by Jim Frederickson and Leon Zolotoy at Melbourne Business School this overload of information from the market – the noise – can actually be used to improve your trading results.
Dr Zolotoy told Trader Plus that the study had built on earlier research, which showed people had to intentionally filter out useless information to make decisions.
“If you imagine a person eating rice, there is a certain amount that a person is able to digest before they will burst their stomach,” he said.
“It’s similar with attention. A person’s attention is a limited resource and there is only a certain amount of information a person is able to digest.
“Think about an investor who is working following news and different results: there are a myriad of different signals attacking him from all over – financial news, interest rate changes, mergers and acquisitions and so on.
“There is more information than this person can digest, so he needs to queue it [in his mind] from most important to least important.”
How does this apply to the stock market? Every day there are a number of companies releasing their earnings figures – for example, in the US on average 80 firms release their figures each day – so there could be as many as 80 signals for the investor to digest.
Within those firms announcing on the same day there is likely to be a range of visibility. For example, a large cap company such as IBM or BHP is likely to receive much more attention from both investors and the media for their announcements than a micro-cap company releasing figures on the same day.
There are simple rules of thumb for this – larger companies will be more visible, topical companies will be more visible (for example BP during the oil-rig disaster in the Gulf of Mexico last year) and companies with unusual trading patterns will also be more visible. The more visible a company is, the more “noise” it will make with its announcement.
“If you think about a particular firm that you may be following, consider two different days. On one day there are other firms which are highly visible releasing their earnings, and on the other day there are a large number of firms that are less visible releasing their earnings,” Zolotoy explained.
“In both cases the announcement is the same. In the first case though, we are distracted much more, so the news of our firm will be less reflected in today’s stock price – but there will be a more complete reaction later on. To trade on that, you just need to pick the day when news about your firm has been more distracted by other companies’ noise and then buy based on that. You can trade on it freely because it is not insider information.”
While the overall movement of the stock’s price may wind up the same in the long run, the ability to profit from the news is magnified when the announcement is lost in the noise.
“Let’s say the earnings news of your firm was supposed to lift the value of your stock 3% overall,” he said.
“This 3% will happen over two periods; at the announcement date and post-announcement date.
“If there are less distractors then the lion share of that price rise will occur at the announcement date. But if there are more distractors then the drift will be much greater in the post-announcement period.”
This movement after the earnings announcement is known as post-earnings drift, and has been observed for up to 60 days after the announcement and is illustrated in Figure 1 (where the red line indicates an announcement made on a noisy day and the blue line is an announcement made on a less noisy day). In both cases the endpoint is the same – a 3% rise – but the change is when that rise occurs.
The application of this theory of distraction to the stock market has also revealed another strength of large institutional investments through managed funds, for example.
“Different investors have different digestive capabilities,” Zolotoy continued.
“For instance, if you think about institutional investors like managed funds and hedged funds, they have large numbers of employees whose job it is to follow the signals. They have much better technical capabilities – in other words, you would expect that their distraction is much less limited.
“This means that if you take a look at firms with shares that are mainly held by institutional investors, then the information about their earnings news is reflected more fully immediately, because there is a lower level of distraction.”
How to apply this to your trading:

1. Work out the  earnings announcement dates of the stocks in your portfolio.

2. Work out what other companies are announcing earnings on the same day.

3. Rank these companies in terms of visibility and size, using the rough guide that bigger companies are more visible.

4. If there are lots of highly visible stocks making announcements on the same day, then buy if it is good news
and sell if it is bad news because the reaction will take longer to be felt on the market and you will be ahead of the curve.
Remember, this is an active trading strategy – it’s not a passive strategy that can be left and applied later on.

If I were an active investor I would follow the earnings announcements of all the firms that are in my portfolio and also the firms that are outside my portfolio, but are announcing their earnings results on the same day as the stock I hold.