Why do markets often overreact to news?

Hero Image

In the financial world, news and global events are of crucial importance with significant influence on the markets. An example that illustrates this thesis well is the VW diesel scandal of 2015. This caused a stir worldwide.

Overview of the VW Diesel Scandal

In 2015, it became known that Volkswagen (VW) had cheated extensively on the emission control of diesel cars. VW had installed special software in the cars that manipulated the emission values during tests in stationary/prüflabor (testing laboratories), so that the limit values in the laboratory fit, but not during normal driving on the road. This led to a massive loss of trust among consumers and investors, which was reflected shortly thereafter in the VW stock market performance.

Market Reaction to the VW Diesel Scandal

The financial markets responded immediately to the published VW diesel scandal. Shortly after the fraud was revealed, VW's stock price fell dramatically by more than 40 percent. Investor confidence was shattered, and many lost faith in the stock. The media extensively covered the scandal, leading to pressure on other brands such as Audi and Porsche, which belong to the VW Group.

After VW's stock price had dramatically dropped in the first weeks following the scandal, it later recovered. This is because some investors believed that the company would overcome the scandal and could recover. Other investors seized the opportunity ("Buy the Dip") to invest cheaply in VW stocks, hoping that the stock price would rise again in the future.

The overreaction of the markets to the VW diesel scandal is an example of how financial markets can react to global events. When news is released that has the potential to influence the market, investors' reactions can sometimes be exaggerated. It is important to note that not all market reactions are reasonable and rational.

Conclusion

The VW diesel scandal has shown that global events such as fraud and corruption can have a significant impact on financial markets. However, investors' reactions to such events can sometimes be exaggerated, and it may be worth being patient and waiting. In principle, it can be said that the stock recovered only slowly, but never really substantially. In the long run, even those who bought the dip in 2015 have not made any profit today.

Why do we address the "old" example of the VW diesel scandal? Because that was the beginning of WAVEALERT: Moritz noticed that alarm functions would help track such events worldwide and buy or sell shares at the right time. With the WAVEALERT alarm, the information about the dip would have been there. Subsequently, based on the news situation, one could conclude that the downturn was exaggerated and there could be a short-term rebound. After an entry and another alarm at +20%, a successful exit would have been possible.