News traders often buy a stock on rumor, and sell it when the actual news breaks. This allows a trader to position before a stock pops higher from a news announcement. The old cliche “buy the rumor, sell the news” means that rumors can sometimes have one effect on a particular stock’s price movement, and news can have the opposite effect. This is a very risky strategy as most rumors turn out to be false.

If the actual news is better than the rumor, the stock could move even higher. Conversely, if the actual news is worse than the rumor, the stock could move lower.

Buy the rumor, sell the news is usually a short-term strategy and explains why some stocks trade up into the big announcements, and then sell off immediately after the announcement.

For example:

1. Rumors are circulating that ABC Corp (trading at $12 a share) might be bought by DEF Corp for $15 a share. If most traders believe the rumor is credible, ABC Corp might run up to $15 a share. If only some traders want to gamble on the rumor, ABC Corp might run up to $14.50 a share.

2. ABC Corp might trade higher for weeks, right up until the details of the takeover are revealed. If ABC Corp comes out and says the rumors are false, the stock will come crashing back down. If ABC Corp declines to comment on the rumors, some traders will sell the stock while some will bet the rumor is true which is why the company doesn’t want to comment. If ABC Corp confirms the rumors, the stock will immediately go to the rumored price of $15 a share.

There are many different types of rumors that cause a stock to behave different. Some rumors could be about a potential big deal in the works. Other rumors could be about a CEO getting fired. Still other rumors could be about an SEC investigation into a company’s practices.

No matter the rumor, the goal of news traders is to buy the rumor, sell the news.

<< Back to Glossary Index