It is safe to say that no stock will ever go open up in a straight line. There will be periods of excess buying and periods of excess selling which can create volatile movements in share prices. These movements can be further exacerbated with good or bad news. In this article we will look at stocks which have been hit by bad news, rumours or untruths and when might be the right time to buy.
Momentum is everything
If you invest in stocks and shares you will very quickly realise that momentum is a big part of investing. As the following of a particular company continues to grow there will be more interest in the shares, they would be more liquid and larger investor such as institutions might become interested. If the news is positive, the strategy is working and the share prices move on upwards this can create significant upward momentum.
On the downside, if a company announces disappointing news then the impact could be dramatic and long-lasting. This type of trend can be even more pronounced with growth companies which have often depended on high-ranking paper to fund acquisitions. One thing you can bank on, on the upside and the downside stock markets will overreact and then bounce back, akin to an elastic band stretched to its near limit.
Catching a falling knife
When looking at shares which are under pressure, attracting significant numbers of sellers with no good news in sight, finding the bottom can be akin to catching a falling knife. This scenario best describes trying to buy a share at the bottom as it continues to collapse. If you grab the knife as soon as it hits the bottom you won’t get cut. If the knife continues its high-speed journey downwards, then your hand could get ripped to shreds.
There will be brave investors who have a strong inkling that the selling has been overdone and the situation is not as bad as it might look. They will simply buy at the price which they see as good value and hope for a short-term bounce or a long-term recovery. However, are there any other ways to play a falling share price where the selling has been overdone?
Buy in tranches
If you truly believe that a share price fall has been overdone and there is potential for a short, medium and long-term recovery, why not look at buying in tranches. Unless you are extremely lucky, akin to winning the lottery, you will never buy at the bottom of the share price fall. However, if you can buy three or four tranches of shares on the way down then you will take advantage of downward pressure even after your first purchase. In effect you are constantly lowering your average buying price with a long-term view in mind.
On the flipside of the coin, if you have set aside money in three or four tranches and the share price recovers, continue buying. You will have acquired a significant number of shares lower down and then continue to buy into the recovery – if you see further significant upside.
Playing the long game
Yes, some short-term investors will make a significant profit trading on shares which are been oversold with the potential to bounce back in the short term. These investors will also experience potentially significant losses if they call it wrong (although they may well have stop-loss limits in place). The best way to play a long-term recovery investment is to buy in small tranches on the way down. That way you take advantage of the fall in share price, lowering your average purchase price and you can even buy on the way up once you know the company has turned the corner. Sound simple? It is in theory and in practice but only if you do not let your heart rule your head.