I found my mom reading the papers with much interest this morning.
“Look! The price of this stock has gone down again! It’s time to buy now!”
“Why now?”
She replied, with a bit of hesitation, “Because the price has dropped a lot…”
“How much is a lot?” I asked. But then I kept my mouth shut as she seemed irritated.
When the market is down, many investors look to accumulate stocks even the prices have dropped significantly. While buying low and selling high is a basic investment theory, it is almost impossible to predict market movements.
Pendulum effect in the stock market
This reality reminds me of the “pendulum effect” in psychology that describes one’s mood swings. In the stock market, the term is used to describe the relationship between a stock’s price and its value. The midpoint of the swing is the real value (intrinsic value) of a stock, and the swinging movements to the left or right represent the changes in investor sentiment, which may cause the stock price to deviate from its real value. It is therefore risky to make an investment decision merely based on the stock price. Contrary to expectations, the stock price may have realised its peak or have yet to reach its bottom when you buy in.
Share price should not be the only consideration
Investors should not just only consider the stock price when making any investment decision. When the stock market is down, stock valuations may also come down, making it seemingly attractive in terms of PE ratio, PB ratio or dividend yield. In any case, attention should be paid to the fundamentals, future development and earnings outlook of the companies. Those with strong fundamentals, such as robust cash flows, balance sheets or track records, tend to be more resilient during market downturns. There is no shortcut to successful investing and investors should do their due diligence get a full picture of their investments, and avoid any rash decisions.
