To understand what makes stocks and share prices move, you must first understand a few things about the current pricing of a stock.
This is the one question that every investor will eventually have to face.
At any given time during regular trading hours, a stock has 3 values associated with it;
Let’s borrow something from the economic concept.
You probably remember hearing people talking about supply and demand of basic commodities in the market. The concept is simple.
If there is a larger supply of products in the market than there is demand, the price will likely to fall.
If there is greater demand for products and there is no enough supply to match the demand, then, the prices will probably rise. This is also true with stocks.
Understanding this concept can help you tune some of the market noises that you see day to day in the market.
Let’s look closer at the reasons behind the price drop.
Let’s say Mwangi, Kilonzo, Otieno, Wafula, and Rotich own 100 shares each of Envestreet Financial. One day, they find out that the tenure of Envestreet Financial CEO is coming to an end.
Four of them decided to offload the stock in their portfolio and put up the shares for sale. Unfortunately, due to the news, there is only one investor interested in buying the stocks at the current price.
Mwangi sells his shares. But that leaves Kilonzo, Wafula, Otieno and Rotich all with shares they would like to sell.
There is nobody willing to buy at the current price but one investor has offered to buy it at price one shilling lower than the current price.
Mutua decides to sell to the investor, and the current stock price adjusted to show a current worth that is one shilling less than before.
If Wafula and Rotich decide to sell as well; less than the adjusted current price, they will also push the current price even lower as they seek to find investors to purchase their shares of stock.
So, what can you do if you get yourself up in the day-to-day movement of a stock price?
The important fact to keep in mind is how a price drop affects your overall investment plan.
Below are some of the things that you can do which will determine your future returns from investing.
1. Just sit and wait, no need to make any changes.
There are some situations where it makes sense simply to just sit and do nothing. One of these situations would be: if you are a long-term investor and you believe in the stock.
When you think about Investing long term, you want to think about investing for years and decades, not just weeks and months.
Future-focused investors anticipate to maximize profits with an eye toward long-term investment.
Over the long-term, stocks tend to follow the performance of their underlying business. In the short term, stock prices are nearly impossible to predict with some stock having high volatility.
Second situation is when you do not have extra capital available to invest at this time when the price has drastically declined.
Possibly, you have already invested your cash cushion and you no longer have any cash available to invest in new stocks at lower prices.
2. Might be a good time to buy at a fire-sale price – Buy More Shares.
In some instances, stock crashes should actually excite you as an investor.
Understanding the business difference between value and price is crucial to being excited when the stock that you bought goes down further in price.
When a stock price drops, it’s a good time to get excited. This is because you get an opportunity to buy more of that great business for less.
Decline in Stock prices are typically opportunities where you might be able to purchase stocks of good companies you like that are on sale at a fire-sale price.
The reason is that, if you are going to buy the stocks then holding on to them for the very long term; you want to buy at the lowest price possible.
Short term investors get discouraged by short term price movements but long-term investors are always looking for potential buying opportunities.
3. Re-Balance Your investment Portfolio.
Rebalancing your portfolio can protect you from being excessively exposed to undesirable risks with your investments.
Portfolio rebalancing is important for two reasons:
Decline in Stock prices expose your portfolio into Price Risk – Decline in the value of a security or an investment portfolio.
When you rebalance your portfolio, this will ensure your portfolio exposures remain within your risk appetite.
A good portfolio is one that you have diversified among different types of investments asset classes. Which includes:
Real estate, etc.
In most cases, financial advisors recommend you balance your portfolio using a tolerance thresholds approach.
When using risk tolerance thresholds approach, start by pinpointing those stocks that have diverged enough and have crossed your set threshold.
Then, keep your risk in check, this will actually improve your investing returns of those asset classes that have long-term expected return.
4. Decide at what point you need to bail out of your position.
If the price keeps on dropping, it’s time for you to re-evaluate your position, this is particularly important. Because, it immediately offers finding.
If the price keeps on declining, then it’s time you start reconsidering your position in the stock.
When you notice that the stock is above your risk tolerance, for sure, it makes sense to simply scrap the position and sell off the stock regardless of the price.
This may seem kind of a big red flag. Because, you are buying high and selling low.
Maybe this could have been a mistake you made buying the stock. In that case, the stock does not fit into your investments thesis and does not really hold a place in your portfolio at this time.
Before buying a stock, you should determine what you really expect it to do for you. As long as the stock continues to meet your expectations, there is no need to make any changes even if the price has dropped. It might bounce back along the way.
If recent price momentum is the main reason for you investing in a particular stock, at times this can be a dangerous investment. likely because, research has to be done on the company fundamentals and the business as a whole to make you comfortable holding this piece for the long term.
When you end up influenced by sudden stock movements, it can be harmful to your return especially when you end up making an emotional decision to sell after a recent price decline.
Doing your own research is required before doing any type of investing. Don’t rely just on what someone else has said.
Don’t focus on beating the market and relative performance instead, focus on absolute performance and what you need to achieve with your financial goals.
Remember to maintain a long-term focus when you are thinking about investing.