2 Examples That Prove You Should Buy the Rumor, Sell the News

Source: Thinkstock
Source: Thinkstock

There is a saying among traders that you should “buy the rumor and sell the news.” What this means is that as a trader it makes sense to own shares of a company going into a big news event if investors think that it will add value to the company. This can be an earnings release, the announcement of a new product, an anticipated divided hike, or the hiring/firing of a wanted/unwanted executive. Regardless of what it is, it is usually the case that insiders are aware of the value-adding event before it is officially announced. While it is not official, this news tends to circulate and we hear rumors of the event through the media. Traders will then accumulate their positions in anticipation of the event and this will lead to a rising stock price. When the event comes and goes, the trading catalyst is in the past, and the traders who drove the price higher exit the position and the stock falls.

If you are a trader and you are familiar with this pattern, you can make a great deal of money anticipating that this trend will repeat itself in the future. However, it is easier said than done. The reason is that once the value-adding event takes place unseasoned traders are tempted to hold onto the asset because the event added value to the company. They forget that it was priced into the stock before it actually happened and rationalize what becomes a losing position. But if you follow the simple pattern and don’t let your emotions take over your investing you can avoid this common mistake and do very well. Here are a couple of recent examples.

Apple’s stock split

The first is Apple’s (NASDAQ:AAPL) stock split. Traders know that a stock split tends to draw in investors, as it is psychologically more satisfying to own more shares despite the fact that doing so means very little if each share represents a smaller part of the company. So while it is not technically a value-adding event it is an event that attracts investor interest, and the same “buy the rumor sell the news” approach works. Apple shares soared after the company announced its upcoming stock split. It even rose in the first couple of days after the split occurred. However, the stock quickly reversed course, and it is down more than 3 percent since. Had you bought the stock into the stock split and sold it right before hand not only would you have made money but if you wanted to you could buy the shares back cheaper today.

Amazon’s new smartphone

Rumors of Amazon’s (NASDAQ:AMZN) new smartphone caused a rebound in the company’s stock after a rough few months at the beginning of the year. Shares rose had fallen from over $400/share to under $300/share before bouncing. As rumors began to circulate about the company’s smart phone, shares began to rise and traded well into the $300s again. While there were skeptics investors, most who bought the stock were anticipating a device that could stand its ground against Apple and Samsung phones while connecting consumers into the Amazon ecosystem. This would boost sales and generate returns for shareholders.

It turned out that this was another “buy the rumor and sell the news” situation. The stock popped briefly once Jeff Bezos presented the phone and then it started to correct from about $340/share, which incidentally is a strong resistance point. So far the shares are down about $10 from that peak, and we now see a double top near the $340 level and the 200-day moving average sits just a few dollars higher at $345/share. In short it looks like a sell even if you believe that the phone will benefit the company.

Ultimately “buy the rumor and sell the news” is a trading strategy, and it isn’t meant for long-term investors. We also need to keep in mind that while there are many instances in which it works this is not a hard and fast rule, so be sure to use stop orders and be able and willing to cut your losses when you are wrong.

Disclosure: Ben Kramer-Miller has no position in any of the stocks mentioned in this article.