Subject: Stocks - Dramatic Price Changes

Last-Revised: 18 Sep 1994
Contributed-By: Maurice Suhre, Lynn West, Fahad A. Hoymany

One frequently asked question is "Why did my stock in X go down/up by this large amount in the past short time?

The purpose of this answer is not to discourage you from asking this question in misc.invest, although if you ask without having done any homework, you may receive a gentle barb or two. Rather, one purpose is to inform you that you may not get an answer because in many cases no one knows.

Stocks surge for a variety of reasons ranging from good company news, improving investors' sentiment, to general economic conditions. The equation which determines the price of a stock is extremely simple, even trivial. When there are more people interested in buying than there are people interested in selling, possibly as a result of one or more of the reasons mentioned above, the price rises. When there are more sellers than buyers, the price falls. The difficult question to answer is, what accounts for the variations in demand and supply for a particular stock? Naturally, if all (or most) people knew why a stock surges, we would soon have a lot of extremely rich people who simply use that knowledge to buy and sell different stocks.

However, stocks often lurch upward and downward by sizable amounts with no apparent reason, sometimes with no fundamental change in the underlying company. If this happens to your stock and you can find no reason, you should merely use this event to alert you to watch the stock more closely for a month or two. The zig (or zag) may have meaning, or it may have merely been a burp.

A related question is whether stock XYZ, which used to trade at 40 and just dropped to 25, is good buy. The answer is, possibly. Buying stocks just because they look "cheap" isn't generally a good idea. All too often they look cheaper later on. (IBM looked "cheap" at 80 in 1991 after it declined from 140 or so. The stock finally bottomed in the 40's. Amgen slid from 78 to the low 30's in about 6 months, looking "cheap" along the way.) Technical analysis principles suggest to wait for XYZ to demonstrate that it has quit going down and is showing some sign of strength, perhaps purchasing in the 28 range. If you are expecting a return to 40, you can give up a few points initially. If your fundamental analysis shows 25 to be an undervalued price, you might enter in. Rarely do stocks have a big decline and a big move back up in the space of a few days. You will almost surely have time to wait and see if the market agrees with your valuation before you purchase.

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