The ‘buy the rumor, sell the news’ is one of the most used fundamental analysis-based strategy in forex markets. It is a strategy based on market common beliefs, or what forex traders believe will occur in a forthcoming forex event. First, a trader buys a currency based on a rumor. Once the awaited event occurs (e.g. a Federal Reserve meeting), and the news has been disclosed he/she abandons his/her positions and the market moves.
In stock markets, traders buy stocks based on the future cash flows that a company is expected to generate. If a company is expected to provide more value to shareholders than previously thought, traders will buy the stock quickly to take advantage of higher expected dividends or stock prices increase. The same happens in forex markets, but instead of cash-flows, traders anticipate interest rate changes.
Traders who use this strategy are usually looking for undervalued currencies. When rumors hint that interest rates may change due to a future central bank’s decision the currency price is expected to increase or decrease over the short or medium term, depending on the nature of the decision. Traders will buy that currency if they believe it is undervalued and they will sell it if they believe it is overvalued.
If a rumor reveals to be not true, or the currency is overbought, then a news story that falls slightly below traders’ expectations will cause a currency sell-off. Only another, unexpected news event that overcome the anticipated rumor will sustain the currency price. If the unexpected news event is strong enough it could push the currency price even higher.