Definition: “Buy the rumor, sell the news” is a saying that refers to a trading strategy where a trader buys an asset based on speculation about an upcoming announcement or data, then sells the asset as soon as the news becomes public. This can give the trader an opportunity to buy the asset before everyone else wants to buy it, profiting from selling it when demand and price increase.
How does “Buy the rumor, sell the news” work?
“Buy the rumor, sell the news” describes a common event in most markets, especially financial markets. Some traders turn this idea into a trading strategy based on what they believe will happen in the future.
Let’s say a trader expects an upcoming economic report or global event to affect the price of their asset in a certain way. When the trader buys an asset based on this instinct, that is the rumor stage of the strategy. Once the event passes or the report is released, the news becomes public. The trader sells their positions, and the market moves.
Note: The “buy the rumor, sell the news” strategy can be used to trade in various financial markets such as stocks, derivatives, the foreign exchange market (forex), and even commodity markets.
Investors using this strategy tend to look for markets that are undervalued. When news or potential information indicates that the asset may yield more future cash flows, this is the “rumor.” It is rumored that the asset will be worth more in the coming weeks or months. Investors will buy this asset until it reaches the point where it is no longer undervalued.
If the rumor is incorrect, or if the market buys the asset so much that it is no longer undervalued, then news that falls slightly short of expectations will cause the asset to sell off. A surprising news event that exceeds the rumor will cause the stock to continue to be evaluated. If the surprising news event is positive enough, it may even push the stock value to a higher level.
Example of “Buy the rumor, sell the news”
A common example of “buy the rumor, sell the news” in the stock market is trading based on expectations regarding a company’s quarterly earnings report. There may be a rumor that the company is expected to deliver more revenue to shareholders than previously anticipated. In this case, traders will quickly buy shares to capitalize on the potential rise in earnings or stock prices. Once the company announces its results or makes its results public, and the shares rise due to strong earnings, traders will sell their shares to take a profit.
These behaviors also apply to the forex market, but instead of cash flows, traders react to expected changes in interest rates. This is how the rumor works in the forex market. When a central bank raises interest rates, it often indicates a strong economy. In this case, forex traders expect the currency’s value to increase. Let’s say a forex trader hears about a plan to raise interest rates from the central bank. Based on that rumor, the trader might buy the corresponding currency. Then the news comes. When the central bank actually moves the interest rate, the forex trader will watch how the news drives the currency’s value up. Once the currency reaches a value high enough to achieve a good profit for the trader, that trader will “sell the news” and trade the currency at a higher price.
Disadvantages of “Buy the rumor, sell the news”
Not Accurate
No one can time the market with absolute precision, and the “buy the rumor, sell the news” trading strategy is no exception. There can be several reasons why this strategy may not yield a profit for traders.
Note:
If there is a rumor among traders about an upcoming news event, it is likely that the market has already moved in the direction of the news or that the information is already available. If that’s the case, the market may not move as much as expected when the news is officially announced, and the trader using the strategy may not achieve substantial profit.
Another example could be that the news itself may not match expectations. For instance, in a bear market, a company that surpasses expectations in its quarterly earnings may see its stock price decline because the good news may not have aligned with expectations.
Decision-making speed
If you are a trader, one of your biggest frustrations is buying something you know is strong, only to see it lose value in a sell-off. There are many reasons that can lead to this, but it may depend on differences in how traders process information. One trader may take time to digest the news before making a trading decision, while other traders act quickly as soon as the rumors come out. Traders who delay acting often provide liquidity for those who know what’s going on. These traders either capitalize on the “rumor” or the “news.”
Conclusion
When a good news event occurs and the price rises, entering at that time may be the worst time to enter the market. This is when everyone who bought the stock at a lower price might be exiting the market to realize a profit.
There are few things in trading more frustrating than being a source of liquidity for other traders. One of the best ways to avoid this fate is to wait for a price reversal after a good news event. It can be beneficial to wait for a temporary reversal in price direction and buy at a better price.
Frequently Asked Questions (FAQs)
How do you learn to trade on news?
Trading on news can be challenging, and prices may not always move in a way that seems logical or related to the underlying news event. To improve your skills in this area, it is best to practice paper trading in a demo account first. Practice buying the rumor and selling the news until you are confident you have a consistently profitable strategy.
What is the best pair to trade on news for the British pound?
The GBP/USD pair is one of the most liquid currency pairs in forex trading. If your trading strategy relies on quick reactions to sudden news events, this liquidity may help you move in and out of positions faster and more accurately. However, if the news event pertains to Britain and another country, it may be better to trade this pair to target that news more specifically.
Source: https://www.thebalancemoney.com/what-does-buy-the-rumor-sell-the-news-mean-1344971
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