What does that actually mean and does it work?
The decision to buy a stock or commodity/asset based on rumors, and then sell it when news breaks, may sound like a dodgy strategy, but it can be very rewarding if execute correctly. We are not talking about insider dealing or knowledge here, that is totally illegal and never happens.
So what is "Buy the rumor, sell the news"
This happens in most markets, particularly financial markets.
In the simple context of trading, it means that if good news is expected sometime in the future, the price will often move higher in anticipation of that date, but not necessarily after and visa versa.
Traders often turn this idea into a trading strategy that draws upon what they believe will happen in the future. We are all anticipating reaction to data or news updates from Central Banks and company CEO, we often try to guess in advance to take the advantage.
Suppose a trader expects that an upcoming economic report or world event will alter the price of their asset in a given way. When the trader buys an asset-based on this instinct, that is the rumor phase of the strategy. Once the event passes or the report is released, the news has been made public. The trader then dumps their positions, and the market moves.
How Does "Buy the Rumor, Sell the News" Work?
In markets outside of the foreign exchange market (forex), traders and investors alike often buy based on anticipated future cash flows.
Perhaps a company is expected to provide more revenue to shareholders than previously thought. In that case, traders will buy the stock quickly to take advantage of increased dividends or stock prices. This behavior also applies to forex, but instead of cash flows, traders often act on anticipated interest rate changes.
Investors who use this strategy tend to seek out undervalued markets. When potential news or info suggests that an asset may produce more future cash flows, this is the "rumor." The asset is rumored to be worth more in the next few weeks or months. Investors will buy that asset up to the point where it is no longer undervalued.
If the rumor is false, or the market overbuys the asset so that it is no longer undervalued, then news that falls slightly below expectations will cause a selloff. Only a surprise news event that beats the rumor will cause the stock to sustain its valuation. If a surprise news event is positive enough, it could potentially push the value even higher.
There are many buy the news, sell the news events in the market. Some of them are:
Interest rate decision - Assets like stocks and currencies tend to rise or fall ahead of interest rate decisions by the Fed, ECB, and Bank of England.
Earnings - Shares tend to do well ahead of corporate earnings and then retreat when the data comes out.
Stock splits - In most cases, companies tend to do well ahead of a split and then lag when the split happens finally.
Economic events - At times, stocks can do well ahead of key economic events like unemployment rate and manufacturing data.
An Example Applied to Forex Trading
One common forex scenario that produces both rumors and news concerns a country's central bank and its interest rate policy. When a central bank raises interest rates, it often signals a strong economy. In that case, forex traders expect the currency's value to increase.
Here's how the rumour works in forex. Suppose a forex trader catches wind of a plan for a central bank to raise interest rates. Based on that rumor, the trader may buy up the corresponding currency. Next comes the news. When the central bank actually moves the interest rate, the forex trader will watch as the news pushes the currency's value higher. Once the currency hits a high enough value to earn the trader a nice profit, that trader will "sell the news" and trade the currency at a higher price.
Trading on a stock split
In mid-2020, Apple announced that it was going to do a stock split. Stock splits increase the number of shares outstanding but reduce the stock price. Stocks splits are typically viewed favourably since the reduced price tends to draw in more investors and increase volume, even though nothing has fundamentally changed in the company.
The price of Apple’s stock rose more than 40% in the month leading up to 31 August 2020, the day of the stock split. Analysts and traders were buzzing about how the split would help fuel the price higher, and as investors piled in, by the time the stock split happened, everyone who wanted to own it was on board. Over the three weeks following the split, the stock fell more than 20%.
Where to find interest rate expectation pricing
For traders interested in trading on interest rate announcements, which can have a significant impact on stocks, forex, and bond markets, here’s how to find out what interest rates are expected to do in the future. It is the expectation that often drives prices. For example, if the Bank of England is expected to raise interest rates, that may push the British pound (GBP) higher against other currencies. This rise may occur before the rate is raised.
The Chicago Mercantile Exchange (CME) publishes the probabilities of what the US Federal Reserve and Bank of England are likely to do at their upcoming meetings. For example, if no change is expected, then it may say there is a 100% chance that interest rates will stay at the current rate. If there is a 50% chance rates will be raised, the expected rate and current rate will show a 50% probability.
How to front-run earnings reports
If a company is expected to have a very positive earnings report, some traders will buy prior to the announcement because they know others will also be buying into the hype. If earnings come out as expected or worse, they may sell. If earnings are much better than analyst expectations, a trader may hold on as the positive news may surprise people and bring new buyers in.
A trader may also use one company’s earnings to help predict what may happen with the earnings reports of other companies in the same industry.
For example, Snapchat reported earnings 44% better than expected in July 2021. Twitter also reported better than expected earnings. Even though earnings from Alphabet and Facebook weren’t due out for several days, these stocks also jumped following the Snapchat news, since traders assumed that companies with similar business models such as Facebook and Alphabet would also be able to beat earnings estimates. Subsequently, the price of Facebook and Alphabet rallied into earnings and then declined when earnings came out. Traders bought the rumour, baking into the price the fact that earnings were likely to be good. When good earnings came out, traders sold the stock and collected their profits.
While analyst opinions and consensus estimates are useful, traders could also look to a “whisper number.” This is what traders believe is likely to happen as new information comes out. For example, after Snapchat and Twitter posted better than expected earnings, traders assumed (“whispered”) that Facebook and Alphabet would too. This information got baked into the stock price, resulting in a rise ahead of earnings.
Implications of "Buy the Rumor, Sell the News"
If you're a trader, one of your big frustrations is buying something you know to be strong, only to see it lose value in a sell-off. There are many reasons why this could happen, but it could come down to differences in the way traders process information. This idea was highlighted in Nobel Prize-winning economist Daniel Kahneman’s book Thinking, Fast and Slow.
"Thinking Fast And Slow shows you how two systems in your brain are constantly fighting over control of your behavior and actions, and teaches you the many ways in which this leads to errors in memory, judgment and decisions, and what you can do about it."
In that case, one trader takes time to digest the news before making a trade, while other traders act quickly as soon as the rumors come out. Traders who are slow to act often provide liquidity for those who are in the know. Those traders then take advantage of either the "rumor" or the "news."
Another example of trading in the forex market
When fears of the Covid-19 pandemic began to surface in February 2020, there was a financial shock. Yet, traders still bought the rumour and sold the news. They assumed that the pandemic would be a global problem, so they bought safe-haven currencies like the Japanese yen (JPY) and Swiss franc (CHF).
The USD/CHF tumbled as fears mounted about coronavirus, and traders bought the CHF (and sold USD). While the impact of Covid-19 lasted a long time, the rumour didn’t. The USD/CHF fell for only two weeks. As more data was released about the severity of the virus, the price completely recovered the decline. Traders who were trading the news bought the rumour by buying the CHF and then sold it right back as more news came out.
The Bottom Line
When a good news event comes out, and the price rises, entering on that good news release can potentially be the worst time to enter the market. That is when everyone else who bought the stock at the lower price may be getting out of the market in order to reap a profit.
There are few things in forex trading more frustrating than being the source of liquidity for other traders. One of the best ways to avoid that fate is to hold out for a retracement after a good news event. It can be more to your advantage to wait for a brief reversal in price direction and buy at a better price.
How to buy the rumour, sell the news
Open a trading account. You will automatically be granted access to a free demo account
where you can practise trading risk-free with virtual money.
Look for high-impact upcoming news announcements. For ideas, see our economic calendar.
Determine, based on consensus estimates, whether the news is expected to be favourable.
Do your due diligence and determine if the asset warrants purchasing in advance of the news or short selling after the event.
Consider placing a stop-loss order to control risk.