Another week to go when people start to come back from holiday and try to make some money before the year end. Until then, the market is trading on thin volume, which is the place to be if you play the manipulation game. Since I am not, I am staying out and waiting for the market to make its next move.

So while we’re sitting on the bench, here’s some food for thought on how to analyse and play market rumours. Now a lot of people simply don’t play them, because they don’t trust their sources. And I wouldn’t either. But there are many out there who have good sources which provide good information. So this is more a post about what to do if you do come across a rumour which ultimately proves to be correct - because believe it or not, even when rumours come true, stock prices don’t alway behave in the way you expect them to. So without naming any names, here are some of the stories floating about today:

1. Company A owns a lot of land which is undervalued. We know this because it just sold off a bit recently at an undisclosed price. Your source tells you that the price is way above the price it accounted for last year. This company still owns a lot more of this land and when the news comes out, its stock price will rise as investors revalue the stock.

2. Company B has received a huge chunk of investment from an undisclosed source - possibly foreign funds. This is not generally known and will be announced soon.

3. Company C is a potential takeover target. This is more or less public knowledge, but what your source tells you is that there are actually 2 bidders who are interested. This is being kept a secret deliberately because the buyers don’t want to start a bidding war. An arrangement might also be reached between the 2 buyers.

4. Company D has is about to win some huge government contracts - not just in Malaysia but overseas.

Here’s the question. Which of these stocks should you buy and which should you avoid? Actually this is a bit of a trick question because all of these rumours have the potential to lead to something good for the company. But what I’m trying to do is to get you to think about what it is that will make a stock price go up.

Now it is very important to think like a lawyer when you hear a rumour. Always question it and play the devil’s advocate. Break the rumour down to useful essentials by thinking how this will benefit the company and the stock price. So in the context of scenarios 1 and 2, the conclusions to draw would be that the companies’ balance sheets will grow and their asset/liability ratio will drop. Is that in itself a good thing? This train of thought should lead you to the next question: how is the company going to grow? What is going to do with all this land or money? If it’s land, is it going to develop it? If so, does it have a record of developing property? Will it be able to rent or continue selling at these prices and generating the same cashflow? Or will it distribute the money to its shareholders? Etc. etc. As you can see, these rumours only bring up more questions.

Re scenario 3, I would ask who the buyers are and why they want that target. Whilst it is true that takeover targets usually enjoy a rising bump in prices, they are also the most susceptible to shark activity, especially if you don’t sell early enough. The other big question I always have (apart from “why”) is “when” is it going to happen? I would also make a mental note that this a trade on the news. I am not trading on earnings growth or any fundamentals. I am betting on the possibility that these shares will be ramped. And implicit in that assumption is that there must always be a more willing buyer when that heppens. So I would also need to know when the news would be reported because I want to be there to offload it ASAP. Without this key information, you might find that you yourself are in fact the last buyer.

Finally, we come to scenario 4 (which is also my favourite). This is the best kind of news for any company because it signifies earnings growth - the absolute key driver of any stock price. All I need to know is how that is going to translate into income and earnings. The bigger the contract the better the sum. In practically every case I have come across, news of this kind of activity always leads to an increasing share price. If I were presented by all of these rumours, #4 would be my first choice.

Hopefully this has provided some insight into how to prioritise your rumours and more importantly how much you should risk on the trade as a result. If you have any thoughts of your own, feel free to post em or write me. I would love to hear them.

Happy Trading!