You might have heard the term “Buy the rumor and sell the news” when conversing with other traders in trading circles or in educational resources focused on investing. It refers to the decision taken by the investor to acquire definite security based solely on rumors. The investor then subsequently sells it when positive news breaks out. It is a phenomenon that is noticed in all financial markets, including foreign exchange. There are some traders who use this concept and apply it to profitable trading strategies, which make this a very important piece of advice.
About buying the rumor and selling the news
Every investor who works with either a financial advisor or a broker is confronted with the financial news in various forms which can make the complex look simple and the risky look safe. Often, stockbrokers might follow up a hot tip with the advice that investors should buy on the rumor and sell on the news. Traders and investors who use this technique buy an asset based on speculation that draws upon a forthcoming economic event or financial news. Once the news passes, they subsequently dump their positions, after which the market moves.
Explaining the rumors
In markets apart from foreign exchange, most traders and investors trade based on their anticipation of future cash flows. However, this is different when it comes to forex, where it is replaced by anticipated interest rate changes. For instance, in stock trading, traders flock towards a particular stock if they feel that the company has the potential to deliver more revenue, which allows them to enjoy increased stock prices.
However, in forex, traders consider anticipated interest rate changes. Traders should look out for undervalued markets and wait for any potential news or information that forecasts more future cash flows. Investors then purchase that assert to a point where it ceases to be undervalued.
What happens if the rumor is false?
The biggest risk an investor can take is acting on false rumors. In case the rumor turns out to be false, or if the asset ceases to be undervalued and starts getting overvalued, any rumor or news story will cause a sell-off. The instrument value can only be sustained if there is a surprise news event that exceeds the rumor mentioned above. The value of the pair in question can go even higher depending on how positive the news in question is.
The 1st step in verifying a rumor is to find out its source. In the U.S., good rumours regarding currencies are hard to come by due to the Fair Disclosure program implemented by the Securities and Exchange Commission. Nowadays, companies and other institutions are required by law to present complete information regarding their management and operations beforehand to prevent anyone from having an undue advantage. Hence, evaluating the quality of a rumor is tougher than ever now.
Examples of Buy the Rumour, Sell the News applied in Forex
The two main types of market sentiment are long-term and short-term. Retail traders do not have the opportunity to take advantage of long-term sentiment as they lack the financial backing needed to trade through volatility. They can instead make money from short-term sentiment. The short-term sentiment is often called “Buy the Rumour and Sell the Fact.” To help us understand this, let’s take a look at some examples.
- The market is expecting the European Central Bank to raise interest rates in the next week.
- Traders notice that the value of EUR/USD is going up till one week is left before the actual ECB announcement.
- During the actual announcement, the market has already priced in the hike and started selling EUR/USD.
- This drives the market lower as major players look to cover their original long orders and take profits.
How to benefit from buying the rumor and selling the news?
To take advantage of this style of trading, you need to stick to the following rules:
- Always try to look ahead a couple of days and always be aware of any impending major news releases. This can be in the form of CPI, Central Banker speeches, interest rate announcements, GDP, etc.
- Try to pay attention to recent news announcements and look for market reactions. If you see that seemingly negative news cannot move the market by much, try to find out the reason why this happened.
- You can have to keep the relationships between the different news releases into account, such as the relation between GDP to Retail sales or PPI to CPI. For instance, if you get a better retail sales figure than expected this week, the market will tend to expect a better GDP next week as well.
- Always watch the market closely the day before the major announcement is about to break. This is preferable at the end of the Tokyo session or an earlier time frame for European news releases. For news releases in the U.S. and Canada, you can watch the market at the end of the London session.
- Look to place the direction in the direction of the market when you see a short-term trend establishing. Make sure to close the trade before the actual news is released.
Traders often make the mistake of buying something that seems to be strong, only to have it lose its value during a sell-off. The worst possible time to enter the market is when the price rises because of positive news. This is due to a large number of traders exiting the market at the same time to reap a profit.
As a result, you become the source of liquidity for others, which is extremely frustrating and not preferred. You can avoid this by simply waiting for a retracement and a brief reversal in price action to purchase at a better price. You can theoretically take any trade after any news release, regardless of its release number, based just on the context of the market