Home > Lessons from the trading floor > Buy the rumor-Sell the news

Buy the rumor-Sell the news

Did you ever wonder why a company reports great earnings and the stock sells off? Well the old Wall Street adage “buy the rumor, sell the news” probably applies.

 

The saying refers to the fact that the stock market is a discounting mechanism. In other words the market tends to react to anticipated future events rather than what is taking place at the present moment.

 

For example let’s say that a company’s earnings are highly anticipated and the stock goes up 10% in the weeks prior to the earnings announcement. By the time the earnings are announced everyone who wanted to be long the stock for the earnings is already long. So that when the earnings are announced buying demand has abated and the only thing the stock can do is fall of its own weight helped by a lack of aggressive buyers and longs looking to take profits. By anticipating the earnings the market has” discounted” the event.

 

The same situation applies in reverse. If a companies stock sells of into an earnings announcement frequently it can do nothing but rally regardless of the news.

 

So the lesson is…. To get an idea of how a stock may react after a significant announcement look at what the price action has been in the recent period prior to the announcement. Think of that price action in terms of the supply of and demand for the stock.

 

Think like a contrarian and don’t get caught without a chair when the music stops!

 

 

www.keystonetradinggroup.com

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