Asset Classes

Free investment financial education

Language

Multilingual content from IBKR

Close Navigation
Learn more about IBKR accounts
Buy the Rumor, Buy the News?

Buy the Rumor, Buy the News?

Posted October 21, 2021 at 12:46 pm

Steve Sosnick
Interactive Brokers

One of the classic market adages is “buy the rumor, sell the news.”  As with many time-tested adages of this type, there is some real logic behind the idea.  Markets are discounting mechanisms.  The current price of a stock (or any other financial instrument) should reflect the market’s best current estimate of the all the factors that might influence the present value of that security.  As expectations ratchet higher, so should a stock price – and vice versa.

Quite often there are events that become widely anticipated by investors.  It can be a positive earnings report, a new product launch, or something broadly helpful to an industry.  As more investors become aware of that potential development, the price of the stock moves to reflect their enthusiasm.  Yet it is common for momentum traders to take the lead, which can cause prices to move simply because they are moving.  When that happens, the price can meet or overshoot the incremental value of the anticipated event.  In that situation, fresh buyers are required to push the stock even higher.  If those buyers are already in the stock, or unwilling to bid it up further, traders become impatient and the price dips – even if the anticipated news is truly positive.  Hence the logic behind “buy the rumor, sell the news.”

Yet when market enthusiasm reigns, that time-tested adage can fail.  We have seen some significant examples of well-anticipated good news becoming yet another reason for buying over the past few days.  Recent earnings reports from Netflix (NFLX) and Tesla (TSLA) are demonstrating “buy the rumor, buy the news” this morning.  In the case of NFLX, we had seen the stock rise over 10% in the month leading up to its earnings release.  That seemed enthusiastic, but reasonable.  Overall market sentiment improved over that time period, and investors began accounting for the global success of the show Squid Game.  Thus it wasn’t a huge surprise to see NFLX sink about 2% the next day despite reporting better than expected earnings.  There was a copious amount of good news priced in and the company reduced expectations for next quarter.   Today, however, the stock has recouped its minor losses and is trading higher.  Enthusiastic markets have a way of improving even upon well-anticipated news and reduced expectations.

Something similar can be said for TSLA, though in its case the post-earnings selloff was finished about a minute after the market opened.  The company reported pro forma[i] earnings of $1.86 versus an expectation of $1.67.  After a 35% run-up over the past 3 months, it would have been reasonable for TSLA shares to experience some profit-taking even after a better-than-expected result.  But that fails to account for the fact that some of that run-up was tied to the increasing value of TSLA’s bitcoin holdings and the rampant enthusiasm of its most avid supporters.  After a brief 2-3% fall in overnight trading, the stock is now about 3% higher and flirting with the $900 level.

Speaking of bitcoin, that proved to be another “buy the rumor, buy the news” event.  The cryptocurrency rallied nearly 50% in two weeks, boosted by enthusiasm for the upcoming launch of the ProShares Bitcoin Strategy ETF (BITO), the first ETF linked to bitcoin futures.  That seemed like a classic setup for a buy the rumor, sell the news event.  It is something we alluded to earlier this week, but fortunately we sidestepped the question.  It turned out that the most enthusiastic anticipation for BITO was met and exceed in its first two sessions.   The crypto rallied roughly a further 10% to new all-time highs before giving back about half those gains today.  It appears like a bit of normal profit-taking, and maybe a delayed “sell the news” effect, but bitcoin is still doing a remarkable job of holding its gains.

Despite these examples, I still believe that “buy the rumor, sell the news” is still quite valid.  It is time-tested and logical.  But during buoyant markets, and with stocks or other products that have an enthusiastic, or even cultish investor base, the opposite can be true.  Maybe all news is good news for a certain group of investors.

[i]  Pro forma earnings are used by many tech companies in lieu of GAAP earnings, or Generally Accepted Accounting Principles.  The term “pro forma” literally means “done or produced as a matter of form”, though many stock watchers consider the term to mean “whatever we say they are, ignoring inconvenient expenses.”   TSLA’s 3Q GAAP earnings were $1.476, which is consistent with the usual $0.40-$0.50 differential below its pro forma earnings.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Interactive Brokers, its affiliates, or its employees.

Disclosure: Displaying Symbols on Video

Any stock, options or futures symbols displayed are for illustrative purposes only and are not intended to portray recommendations.

Disclosure: Bitcoin Futures

TRADING IN BITCOIN FUTURES IS ESPECIALLY RISKY AND IS ONLY FOR CLIENTS WITH A HIGH RISK TOLERANCE AND THE FINANCIAL ABILITY TO SUSTAIN LOSSES. More information about the risk of trading Bitcoin products can be found on the IBKR website. If you're new to bitcoin, or futures in general, see Introduction to Bitcoin Futures.

IBKR Campus Newsletters

This website uses cookies to collect usage information in order to offer a better browsing experience. By browsing this site or by clicking on the "ACCEPT COOKIES" button you accept our Cookie Policy.