Market Psychology: Buy The Rumor Sell The News

Back To The Trading Basics Of Market Psychology

One of the many facets of trading important to your long-term success is understanding market psychology. When it comes to trading basics, understanding market psychology is among the hardest concepts because money makes people stupid (including yourself/myself) and stupid people do irrational things.

The market, all the people participating in equity exchanges including the buyers, sellers, brokers, analysts, and pundits is a vast crowd. It is filled with the smartest people in the world, people driven by greed and fear, and can’t be “beaten”. At best, a trader can hope to become attuned to the flow of the market and able to profit from that flow.

When it comes to the market flow, the market moves on what it perceives will happen in the future. What I’m saying is, today’s prices reflect conditions the market expects to have in the future. The easiest way to explain this is with earnings. When I a company is expected to grow its earnings or to outperform its guidance its shares will move higher. This is because investors and traders see a value at today’s prices relative to the future results. If that same company continues to grow business and foster and expectation of higher future profits that stock will keep rising over the long-term.

Likewise, if business is flagging, or if economic conditions suggest weaker earnings to come, the market will sell and prices will fall. That’s what happened with this most recent correction; the coronavirus pandemic created conditions in which earnings were expected to fall and the market sold off. This phenomenon is called discounting.

Buy The Rumor, Sell The News

Buy-The-Rumor-Sell-The-News is a catch phrase that describes exactly the psychology I am talking about. When the market thinks something is going to happen, “the rumor”, it’s time to trade. Because trades could be long or short, bullish or bearish, it may be better to say Enter On The Rumor/Exit On The News, but I think you get the idea.

Depending on the rumor the trade can be bullish or bearish. If a company is rumored to have made a new deal you might want to trade bullish, if the rumor says a deal is falling through you may want to trade bearish. This is the “discounting” phase, the time when most traders make money. Why? Because when the news is confirmed price action has probably already adjusted to the expectation.

This is why a lot of assets will shed their gains or stage a rebound when the rumor is confirmed. This is the Sell-the-news part of the adage. Putting this in perspective of today’s equities market, the rebound is a “buy the rumor” event. The rumor is the pandemic is peaking and a rebound is in sight. When and if the market discovers this isn’t true, or not as true as it would like to believe, I think we’ll see a “sell the news” event unfold.