In the last blog, I suggested that the next topic would be the effect of shale gas on productivity and economic expansion in the USA, and prosperity in the Middle East and in third world oil producing countries. However, that blog is slightly delayed in order to discuss some current market issues.
Why Stocks Sometimes Fall When Good News is Announced
The examples of this of everywhere.
Shareholders and management of companies are likely surprised by this effect which is counter intuitive, yet the reasons are obvious to market traders.
For those investors who seek value, and who are looking for a good investment, either stock may be a prime candidate, in spite of the fall in value.
Buy on Dips
One interesting way to cope with this phenomenon, is to be aware that this happens, and look to buy stocks that fall with good news announcements. A stock that has been driven down for artificial reasons, is sometimes a very good buy.
There is a market adage that says – “Buy on Dips”. The idea is that the buyer gets very good value at a discounted price.
How The Stock Market is Supposed to Work
There is a belief that value is recognized in a stock when the underlying company creates some value or furthers some objective.
The common belief is that if a positive event occurs, the stock will rise in value, and all stockholders will benefit.
The Reality of the Stock Market
I often repeat that value investing means accepting short term volatility in the price of the investment. Buying real value means that you are in a minority group of stock market investors.
By far, the greatest number of trades in almost any security, is done by traders and professionals with other motives in mind.
A trader in the market, is a person (or computer) that buys a stock or pre-sells a stock (selling short) in the belief that the short term trend of that stock will be in a direction that makes the trader a profit. Long term value investing is irrelevant to Traders. All that is important is making enough trades that are profitable. A trader accepts that a number of trades will be losses. The objective is to have more trades that make money, than trades that lose money.
Program Trading
The majority of trades today, are programmed trades. That means that a computer has been programmed to buy or sell a security based on a number of indicators that are preprogrammed. The rapidity of these trades can be beyond your conception, with literally millions of trades occurring daily.
So long as at the end of the day, there have been more wins than losses, the mission has been accomplished.
Selling on Positive News
One would think instinctively that when a company announces positive news, that the price of the stock would be bid higher. But this is often not the case.
Why This Happens
This explanation is short due to space limitations and I will try to expand the topic in a future blog.
Often when a company is raising money, especially in the junior mining sector, a warrant is offered as a part of the offering in order to make the offering more attractive. Most professional traders will sell the stock at any price they may realize that is above the cost, in order to be in a position to exercise the warrant. The original purchase of the private placement, the sale subsequently of the stock, and the exercising or sale of the warrant is all considered part of the same trade. If the net of all three transactions is positive, the trader has made his profit for the day.
If enough traders follow this strategy, there are more sellers than buyers on that day, and the price of the stock falls.
There are many other similar reasons for this occurrence. Traders need to move capital in and out of stocks, and rapidly. When good news comes, a stock generally gets some attention and more buyers appear. The easiest place to sell a stock, is when there are lots of buyers for a stock.
Traders watch for good news, and sell the stock into the good news market in order to raise capital for their next trade. The amount of profit to be made by holding a stock until the next news release is irrelevant to them. A profit is a profit is a profit. They take a profit of any amount when the profit is available to them. And then “on to the next trade”. All day, every day, on to the next trade.
Smart Value Investors
Smart value investors know that this phenomenon occurs with regularity and watch for the dips when they buy the stock.
The views expressed in this blog are opinions only and are not investment advice. Persons investing should seek the advice of a licensed professional to guide them and should not rely on the opinions expressed herein. This blog is not a solicitation for investment and we do not accept unsolicited investment funds
