Just one day after European stocks had a big rally, prices fell down back to normal levels after rumors of the European Central Bank cutting bank on their quantitative easing policy. The Stoxx 600 dropped by about 0.5 percent on Wednesday, October 5th, as a result of these worries. While they might be just concerns and not yet facts, trader psychology—as you know—has a profound impact on asset prices. Even if they are unfounded worries, day traders in the stock market, the Forex market, and the binary options market can be hurt if they are not also taking psychological factors into account, too. And that’s true even for rumors. Powerful rumors can hurt or help prices over the short term, and even if they are not based in reality, they can hurt you if you aren’t careful.
The English FTSE 100 is coming off of a record high from just a few days beforehand. During the trading day on Tuesday, it hit an all-time high point before closing just off of that. And while the FTSE did drop on ECB rumors, it wasn’t hit nearly as hard as other European indices were. In fact, this is an area where the Brexit has actually helped the English economy. The pound sterling is at a very low point right now thanks to the same event, but British stocks are sitting at very high points right now. Like we see happen in the U.S. economy, when the English currency drops, stock prices and their supporting indices become more attractive and prices rise in this alternative marketplace.
While we know that rumors can hurt us, those same harmful rumors can also help us. Let’s say that we know that a rumor is not based on reality, and that any short term action is likely to correct itself shortly after. Even if we stay away from the initial trades, there is still plenty of opportunity to profit off of the public’s reaction. We’ve seen this happen many times throughout the course of history. However, we will illustrate a basic strategy here with a fictional example.
Let’s say that you’ve been watching a high profile tech company. They have a very charismatic CEO, and experts always speak very highly of her and her ability to innovate new, cutting edge, products. Many hedge funds have been taking long positions in the company because there are rumors that this CEO has a brand new idea and is leading the company toward an industry changing breakthrough. This has helped boost the company’s stock price even more. Early in the morning, before the trading day begins, a rumor surfaces on Twitter that the CEO has died in a car accident. When the trading day starts, the stock price drops in a major way thanks to the rumor.
You have not sold off any shares of the company, and you have not even traded the company recently because you were skeptical of the rumor—which thankfully has proven to be false. However, because of the strength of the drop, which we now know was completely unfounded, you take a long position—it doesn’t matter if it’s with a sizeable day trade or with a set of call binary options—and you are able to profit as the company’s price goes back to where it rightfully should be.
As a trader, it’s important to know how to approach these things. Rumors are not always true, and sometimes they are just partially true. Being able to gauge the public’s reaction to news is important as you establish positions, but it’s also helpful to be able to play the rebound here, too. As the ECB’s actual decision on its QE emerges, it’s important to remember this.