Short-Term Trading Strategies

Short-Term Trading Strategies

Buying Rumors and Selling the News

Buy the rumor, sell the news’ is a short-term trading strategy based on the belief that markets predict future events.
If you follow financial media, you may have heard the expression buy the rumor, sell the news in relation to a stock. Where exactly do you buy a rumor, and how do you sell the news? Why would you buy a rumor when the ones you normally hear amount to little more than office gossip? Buying rumors and selling the news are short-term trading strategies based on the premise that markets forecast events. In fact, some traders believe that price movements in stocks predict legislative changes, conditions in the economy and even military actions as much as six months before the conditions materialize or events appear in the headlines. Traders buy rumors because by the time a rumor becomes news, the news is already reflected in the price of a stock. Conversely, selling the news ensures that you won’t be caught in a trade that played itself out a day or a month ago.
Buying on rumor and selling the news is a popular approach to speculating on take-overs of publicly traded companies. As bids from acquiring companies are usually offered at a premium to the stock price of the company being acquired, you can expect the shares of the targeted company to rise on a rumor of a friendly or hostile take-over bid. Most of these rumors come to nothing when the supposed acquirer announces that it has no intention of making a bid. However, speculative interest in the stock of the target company can push up the price by 20% or more.
If you think you can buy on rumor and sell the news about a stock, the following points will help you distinguish rumors you can buy from rumors that will never become news.

Stock Tips Are Only As Good As Their Sources

Who or what is the source of the rumor you heard or read? What do you know about the integrity of the source? Normally, home-gamer traders are only exposed to stock tips through the musings of financial writers on the web. If a journalist claims to quote a ‘reliable source’ or ‘an insider who didn’t want to be named,’ you’ll need to consider the track record of the writer or analyst who’s presenting this information to readers. Are you familiar with this financial writer’s work? Do you have some basic faith in the information he reports?

Buy Rumors of Acquisitions That Make Financial Sense

 

A financial writer who lends credibility to an unsubstantiated story will usually offer reasons why the rumor makes sense. For instance, he might argue that a contender for a lucrative contract will be awarded the business based on deals made in the past. Sometimes, stories circulate about mergers between companies with hefty market capitalizations. These rumors are generally suspect because regulators don’t like to approve a marriage of entities that creates a near monopoly, leaving consumers or suppliers with fewer options.

On the other hand, if you hear a rumor that a company will be acquired, you need to find out if the proposed acquirer is carrying debt or having difficulty accessing financing. How will the acquirer pay for its rumored expansion plan? Can the company really afford to take over another company?

Stock Prices Are the Acid Test of Short-Term Trading Strategies

 

The stock that should benefit from the rumor you heard or read will tell you if the rumor could become news. If the stock in question has already moved on speculation of a take-over bid, the key is determining how much higher it can go before news discredits or confirms the rumor. If the stock price is flat or has fallen in recent weeks, traders don’t believe that the rumor will become truth. You can still bet against them, but when it comes to short-term trading opportunities, the market is generally right. Furthermore, stock prices tend to exaggerate investor sentiment, both to the upside and downside of the trend line. A lack of enthusiasm for the stock therefore shows a lack of confidence in the credibility of the rumor or its source.

Buy the rumor, sell the news is a short-term trading strategy that carries considerable risk. Ideally, you would speculate on a company you already know and a stock you might buy if you knew the rumor wasn’t true. As with all short-term positions, you still need to do your due diligence in addition to checking for news that will provide the next catalyst for your stock. That said, committing an amount you can easily afford to lose may save you from heartache and will certainly teach you more about price movements and market psychology than you can learn from a book.