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Buy the Rumor, Get the Blues

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You've no doubt heard the Wall Street adage "buy the rumor, sell the news." The idea is that, by trading on some rumored positive news for a stock, you will take a position ahead of the crowd, and then sell as other investors rush in when the rumor is confirmed as a fact.

One big problem I have with this notion is that it seems to ignore all the instances where rumors are -- gasp! -- not true. How often is that the case? Almost all of the time.

Remember when Vale (NYSE: VALE  ) was supposedly preparing a $25 billion bid for Mosaic (NYSE: MOS  ) in July? Or how about this month, when Applied Materials (Nasdaq: AMAT  ) was said to be readying an offer for Energy Conversion Devices (Nasdaq: ENER  ) at $18 a share, and MEMC Electronic Materials (NYSE: WFR  ) was rumored to be a buyout target once again?

Takeover rumors aren't the only ones that can lead to big disappointment for those hoping to sell the news. Take the case of Delta Petroleum (Nasdaq: DPTR  ) , where rumor fed upon rumor, leading to a truly impressive speculative run.

On Sept. 8, Delta shares ran up about 16% on strong volumes. The following day, word began to get around that Delta had landed approval to drill four high-impact exploratory natural gas wells in Washington state. That rumor, which turned out to be true, no doubt fueled anticipation surrounding the Gray well, which Delta was in the process of completing. The stock exploded 33% higher on a staggering volume.

Waves of traders rushed in over the next seven trading sessions, taking Delta's share price from under $2 at the start of the month to over $4 a share by last Friday -- which, funnily enough, was options expiration day.

Anyone hoping to sell the news of a monster well was sorely disappointed today, with the announcement by Delta that Gray had not flowed commercial quantities of gas in any of the zones tested. Not only that, but Delta was curtailing additional drilling activity while it puzzled over these piddling results. I've closed my underperform call over on Motley Fool CAPS at a handsome paper profit.

There is arguably such a thing as intelligent speculation, but "buy the rumor, sell the news" is not how it's done.

Fool contributor Toby Shute doesn't have a position in any company mentioned. Check out his CAPS profile or follow his articles using Twitter or RSS. The Motley Fool has a disclosure policy.

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