Wednesday, January 21, 2009

Buy on the rumor, Sell on the news

Market always reacts to 'surprises'. Imagine it is Feb 14th, the Valentine's day. You come home in the evening. You bring your wife a beautiful diamond ring and surprise her. Your wife gets so excited and she expresses her happiness and cheer to you. The same thing happens in the stock market. When investors get 'positively' surprised, they send the stock market UP.

Let us see what happens in the following scenario. You tell your wife that you'll bring her a beautiful diamond ring in the evening. But, you come home late, and that too empty handed. What will be your wife's reaction? She'll be very disappointed and you may not even get your dinner. The same thing happens in the stock market too. When investors get 'negatively' surprised, they dump the stocks and send the stock market DOWN.

When a 'rumor' becomes 'news', the element of 'surprise' is gone. Investors buy stocks when there is still 'surprise'. They dump stocks when the 'surprise' is gone i.e., when a 'rumor' becomes news (or, when they are 'negatively surprised'). If you want to really ride with the wave instead of riding against the wave, "Buy on the rumor, Sell on the news".

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