A Clear Example of “Buy the Rumor, Sell the News” (or Vice Versa)

June 24, 2010
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You’ve probably heard the old expression, “Buy the rumor, sell the news.” Wednesday’s action gives a clear example of exactly what that means.

XHB, the popular homebuilders ETF, has been in a pronounced downtrend since late April. On June 23rd, the market was rocked by record low new home sales — a number considered shockingly bad relative to expectations, by Peter Boockvar’s account the worst since 1963.

So what happened when that horrid news hit the tape? XHB (and a number of other builders) actually whipped and surged instead of tanked… and did so on major volume, as you can see from the chart above.

Why did this happen? Because a number of players were already heavily short… and they saw the awful data point as a chance to cash in. (Hence, “buy the rumor and sell the news” — except this time in reverse.)

Does this mean the XHB downtrend is over and done? Not necessarily. But it’s an important consideration nonetheless… and an instructive example of how markets can confound novice traders.

Trades Are Like Poker Hands

The XHB “cover on the news” reaction is also an example of how trades are like poker hands. There are always other players at the table… and in respect to trading profits, you’re playing a zero sum (or even minus sum) game with whoever else is in the hand. This means that, in addition to the fundamentals and technicals, as a swing trader you should be cognizant of what your opponent may be holding.

Depending on the situation, sometimes the cards (i.e. fundamentals) are all that matter… but more often than not, psychology and positioning are key. And sometimes, in fact, the setup can be such that the cards don’t matter at all.

To quickly sum up:

If a major piece of news has been anticipated by a large enough group of traders, that news item may actually stall or even reverse the trend (due to a burst of profit taking).

If that big news item catches a large group of traders off guard, however — if a major contingent of market participants are snapped out of a daze or caught leaning the wrong way– then the table is set for a major directional push.

Thus the best answer to the question, “How will a big piece of news move the market?” is almost always, “It depends on how the players (other investors and traders) are positioned.”

This is SO key to understand, and all too FEW investors and traders really get it:

  • The markets are not just “fundamentals” (as many investors assume).
  • Nor are the markets just “technicals” (as many pure chartists assume).
  • You really need awareness of at least four separate components — fundamentals, technicals, sentiment (psychology), and player positioning — to have a true sense of the fluid dynamics behind market moves.

JS

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One Response to A Clear Example of “Buy the Rumor, Sell the News” (or Vice Versa)

  1. videos xxx on June 29, 2011 at 10:14 am

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