You have almost certainly heard the expression “Buy the rumour, sell the news”, but do you know what it means?
We recently did a very local straw poll, and of all the people we asked, just two could come up with a reasonable answer as to what it means and how to apply it to your trading strategy, though we did get several creative wrong answers.
Anyway, if you don’t know what it means and are interested in finding out (there are some good reasons to be interested), why not spare a few moments and read on?
And if you do know and you are the kind of trader who follows its advice, you will tend to open a position on advance speculation of a news announcement that can change an asset’s price. But is that a reliable strategy?
Buy the rumour
Financial markets often respond strongly to news announcements, and many traders, we will call them news traders, base most of their trading decisions on breaking news, economic reports, company declarations and so forth.
However while such announcements affect an asset price, so too can speculation ahead of the statement – usually, there is plenty of speculation going around. Traders love to listen to gossip when it can impact their profit.
That deals with the first part of the adage, “buy the rumour”. But what about the second half, “sell the news”? Unfortunately, not all rumours and gossip get it right. Sometimes, the announcement is entirely at odds with the speculation.
A recent example is the Bank of England’s decision to maintain the base rate at its current level, which flew in the face of expectations – just about everybody expected the BoE to increase the interest rate.
Sell the news
If a sufficient number of traders open or close positions based on the rumour, they will affect the asset’s price. By the time the announcement is made, its effect is already priced into the asset’s value.
If the announcement is in line with the rumour, its effect might increase the asset value. However, if the rumour merchants got it wrong, the price could fall considerably, leaving traders with open positions nursing an unexpected loss.
In the latter case, the advice to sell the news makes sense, as the strategy avoids the loss associated with an unanticipated announcement. Moreover, by selling just before the announcement, you seal in your profit and avoid the downturn following the news.
But there is another factor to consider. Even if the news is in line with expectations, news traders will, at that point, close their positions, causing the price to fall. Thus, selling the news will again avoid having your profit wiped out by post-news price falls.
An example of “Buy the rumour, sell the news”
As an example, let’s look at the recent decision of the Bank of England to maintain current interest rates. Here we refer to the announcement made in November 2021 when the Bank’s Monetary Policy Committee voted by 7-2 to keep its benchmark interest rate unchanged at its historic low of 0.1%.
This decision went against investors’ expectations that the BoE would be the first central bank to increase interest rates following the coronavirus pandemic.
Following the announcement, sterling fell sharply by around 1% against the dollar. In the face of rising levels of inflation forcing the BoEs hand to raise interest rates, many traders bet that the value of the GBP would rise against the dollar.
Those who were wise enough to close their positions before news impacted prices locked in a reasonable profit; however, those who failed to do so made a significant loss.
Looking at the figures, in the immediate runup to the announcement, GBP to USD went from 1.360 – the place to buy the rumour – to 1.369 – the place to sell the news – then following the announcement on 4th November it plunged rapidly to 1.343.
Is news trading a great strategy?
If you have an excellent in-depth understanding of the market and can make educated guesses of how news can affect it, then news trading can produce significant profit for day traders.
Globally, there are daily announcements that can impact currency values and often, rumours precede them. If you are clever enough, you can capitalise on these.
Of course, the strategy works only if sufficient traders are buying the rumour to affect prices. It also means you have to monitor market news and announcements very closely.