Have you heard about the "buy the rumor, sell the news” strategy? Is it capable of making us identifying good trading opportunities with high rates of profit?
Many traders see news releases as a good opportunity to react, but some others may shy away from it. They avoid the market when important news is about to be released. A few who capitalize on it though, are familiar with a specific term called "buy the rumor, sell the news".
Also known as "buy the rumor, sell the fact", it is quite a risky plan but may bring you a good sum of fortune if you can execute that plan correctly. Traders on the stock market often do the same thing as well. They buy shares of a profitable company to earn a good amount of dividends. But as soon as the cum date/ex-date has passed, they release their shares back to the market. That is how the precarious "buy the rumor, sell the news" worked on the stock market. Oftentimes, the price drops after the dividends are distributed.
On the forex market, "buy the rumor, sell the news" is often seen when the traders are anticipating a change in interest rate. They seek undervalued or oversold currency and when a rumor about its increase in value is spreading, they buy said currency often to the point of overvalued.
This strategy can also be done in reverse and is called "sell the rumor, buy the news". The strategy is planned when the interest rate is about to go down. For example, when the trader thinks that a certain central bank is going to reduce its interest rate around 25 points, he will short it to the point or even beyond the undervalue threshold. After the central bank actually announces a decrease in interest rate, he will immediately take profit from that short position.
Nevertheless, the scenarios around an interest rate announcement are not always the same. The opposite things can happen as the market is truly unpredictable.
The Implication of "Buy the Rumor, Sell the News"
This strategy might be tempting, but take some time to ponder upon the risk it carries with. Despite the common perception that good news means a bullish market and bad news equals a bearish market, everything is not that simple.
As a matter of fact, a short-term shift in exchange value is often caused by perception toward market sentiment and less likely caused by a certain theory. The rise in interest rate does increase the exchange value of a certain currency, but it will only happen in the long run. Besides, the interest rate is not the only cause for an alteration in exchange value. There are many other things to consider as fundamental factors.
Besides, are you really certain of the news you have heard? It is true that uncertainty is an everyday occurrence, but would not it be better if we can make it as certain as possible? Sometimes, the price goes in a direction that we do not expect. Daniel Kahneman, an economist and a Nobel Prize winner, once wrote in his book that traders process information differently. This leads to the many unpredictable outcomes that can trap unassuming traders who still rely on common theories.
A Risky Path For Traders
For beginners or even experienced traders with conservative tendencies, the aforementioned discussion might be enough to avoid the "buy the rumor, sell the fact" strategy. Another reason to stay away from this method is that the moment before or after a news release is the worst time for trading because there is a contradiction between theory and reality.
Without any information coming from an insider, there is no way we can accurately predict where the lines are heading. Although the only thing that is certain in forex trading is uncertainty, said moment is much riskier than other situations. That is why taking advantage of market euphoria on news releases can be the worst moment to trade.
With all that being said, no one forbids you from stirring up the market by following the "buy the rumor, sell the news" strategy, because some people do earn a nice profit out of it. But rather than be crushed by uncertainties, it would be better if we just wait until the news is settled and the market has digested the information published. It will be easier to identify the sentiment following the news release and where the price heads after. This way, you can detect trading opportunities from price trends, retracements, or reversals.
Understanding a strategy is not the only crucial thing if you want to profit consistently from the market. Should you find a trading opportunity, you need to be able to figure out the ideal entry and exit positions. To read about it further, you can explore All About Entry and Exit Strategy.