Rumours And Financial Markets

Monday, 20 April 2015
"Rumor is not always wrong."

Rumours are the oldest mass medium in the world. Their characteristics are difficult to understand. Rumours have mysterious qualities. They create unease, nervousness and excitement. They agitate people’s minds and contrast from information because they are not confirmed immediately. The defining characteristic is that a rumour is not in itself false but lacks verification. Rumours differ from legends because they don’t former don't typically take the form of a narrative, while the legends always do. "A legend is an actual story of doubtful truth, whereas a rumour is just an unverified report." A report may consist simply of unverified statements, opinions posing as facts, a grain of truth misunderstood or misrepresented to the extent of being false, half-truths purposely exaggerated or downright lies.

Rumours have key characteristics. They comprise transmission by individuals or various media, topical within the public domain and reception that meets the emotional needs of defined communities. Rumours are transmitted by word of mouth; they provide "information" about a "person, happening, or situation". They express and gratify "the emotional needs of the community".

Sociologists have categorised rumours as wish-fulfillment rumours, expressing the wishes and hopes of those who circulate them, anxiety rumours, expressing the fears of those who circulate them or divisive rumours, motivated by aggression, prejudice, or hatred on the part of those circulating them.

Of course financial markets are one of the oldest but perfect medium for rumours. It is a community in the sense that the number of participants is limited. The participants are all experts (well so they claim!) in the sector. The sector suffers from news and information overload. Moreover news and information is time critical and financial risk is always involved.

Are rumours in financial markets a matter of mystery or do they follow strong logical mechanisms which can be analysed? Does such analysis enhance the understanding of rumors for example by the way in which they evolve, by what is the catalyst for their growth or by their acceptance and the price implications?

Rumours in financial markets, in general, evolve spontaneously. While some market participants agree with a statement, others will believe the illusion of a strategic operating source steering the market in the direction it wants. While rumours are typically transmitted orally or by various media, the critical question is always the source of the rumour. From an analytical perspective a scientific point of view, it’s not the most interesting one. More interesting is clear evidence that non-traders are overconfident in knowing the source of a rumour. The first reaction of the participants, after hearing a rumour, is to verify the news with other market participants and to follow the price movement of the rumour. If the price moves then most likely there is some veracity to the rumour.

Rumours spread because they are believed. If the market participants contact others in the market, they are already inclined to the biased towards the rumour and consider the rumour to have substance. They are looking for confirmation of their opinion. A majority of professional market participants suggest that a rumour is spread within minutes. In minutes the entire market professional community knows the rumour.

Market participants want to believe in rumour. Rumour strengthens the blood which contributes to liquidity and transaction flow. They will confirm that. The key factors, which contribute to belief in the rumour, are the sources of the rumour, the identity of the people, media who are the source of the rumour along with the impact of the rumour on market price movement. Significant minorities of market participants assert that they don’t care if the rumour is going to be true or not. In response to the question does the market as a whole believes the rumour, a very large majority of the participants would confirm that from the price movement, they will deduce if the market believes or disbelieves the rumour. So, do the individual beliefs matter or is it more important to "average belief expressed in the market price movement?"

The role of information networks is critical in the assessment of the views of market participants. The market wants to have its views confirmed. Professional market participants by contrast with others spread rumours in priority order to those who can influence market price movement through large transactions. Information networks are a very important feature when addressing rumours. The latency of information derives advantage to an information networks for a few seconds, minutes at most.

Is it possible to make systematic profits on rumours? Price patterns of rumours are highly comparable to those of information. The creator or source of the rumour has a good opportunity to make systematic profits. Market action after the price has moved is a clear ear signs of herd behavior. Herd behaviour leads to transaction flow, excess volatility and longer- term price reversal. Such behaviour leads to trends, trends that can be helpful correctly It is easy to identify a trend, but is it worthwhile joining the trend? How does one know its scale and its turning point- questions arising from rumours are the same as questions deriving from any event or piece of news. They must be addressed as they arise.

This article is part of Robert McDowall's series on Folklore & Finance.