'Buy the Rumor, Sell the News' forex trading strategy (part two)

Central banks’ decisions on money supply and interest rates are the most common events that generates both rumors and news on the forex market. When a central bank undertakes an expansionary monetary policy (e.g. it hikes interest rates), it ususally hints that the economy is in a positive phase of the economic cycle. As a consequence, forex traders expect the domestic currency to appriciate.

If more and more forex market participants start to believe that a central bank will hike interest rates, perhaps because of the central bank’s forward guidance, this common belief generates a “rumor”, and traders react by buying the domestic currency. Later, when the central bank actually hikes the interest rates, generating the “news”, forex traders observe the currency’s price going up. Once the price hits a high enough value to grant the trader a profit, that trader will sell “the news” and the currency.

The choice on when to enter the market is fundamental to earn a profit. This choice depends on differences in the way traders process available information. Traders are not all alike and react to rumors and news in different ways, deciding when to buy and sell. Some traders are slower than others to react when a rumor comes out. In the market liquidity mechanism, the slowest traders provide the liquidity for the fastest ones and the latter usually take advantage of either the “rumor” or the “news.”

The worst time to enter the market is often when a positive news is published and the currency price rises, because it is right the time when those traders who had previously bought the currency at a low price decide to exit the market and to succesfully liquidate their positions. Most of the times, the best strategy to avoid a loss is to wait for a price retracement after a good news is published in order to buy later at a higher price.

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