What goes UP must come DOWN! Is the law of physics TRUE with STOCK PRICES too?
(Photo credit: https://finance.yahoo.com/news/happened-stock-market-today-210300761.html)
If you see stock prices slowly increase over time with little or no fluctuation, only a rising trend, you tend to think this is a good signal. In fact, it is and it isn’t.
Of course, it is a good signal in terms of the confidence the market has in this company. If it slowly starts to increase and never goes down it means that people believe it is truly going somewhere and the profits will come soon enough or maybe are already coming. True. However, if there is anything a company can know for sure, is that nothing stays the same. There will be good years and bad years and often nothing to do with what is going on inside the company. So many things can happen out there in the business world that can rock and beat up a company easily. However, the longer it stays in business the better the resilience for comebacks can be.
In terms of it being a bad signal, it can really only be determined based on however long it has had it’s increasing run, and whether it has had any crashes in the past. I think the most famous saying from the movie ‘Wall Street’, is ‘don’t trust a business that hasn’t already seen the bottom of near bankruptcy’. This is because the operators of the company will have no way of dealing with a collapse should it happen. The greatest thing about the ups and downs of business life and in turn stock price, is that the downs always force business owners to be creative, resourceful and courageous. The more this happens, ‘experience’ is built and so the future lows may not be as bad as the previous lows, only because the owners know how to deal with danger.
According to Candy Schaap a Technical analyst on Investopedia https://www.investopedia.com/articles/trading/08/stock-cycle-trend-price.asp, we can expect our stock prices to move in a four point cycle. Accumulation, mark up, distribution and mark down. A technical analyst is specifically interested in price trends and this 4 point trend is very interesting.
The accumulation phase refers to the first influx of money, usually the big guys like investment funds, and big companies, etc. This phase helps builds the companies credibility. But this can be a volatile time for an individual investor as stock prices can go up and down very quickly, so best to stay out until things stabilize.
Then comes the second phase of the mark up, which is where the prices rise to more than they are really worth, this is because the initial investment from the big guys drives up the price in a more realistic way and in return the stock starts to make money for the investor. Individual investors can get good returns during this period.
The third phase of distribution starts when things begin to level out price-wise as investors start to realise that maybe the price is too high. This is the most dangerous time of the stock price trend mainly because no one can fully know it is happening until after the event. This is the most critical time an investor can lose a lot of money. This is also the time when investors who once were short term investors decide to become long term investors, because they decide they don’t want to lose their money, and for as long as the stock is not sold, they are still in the game.
The last part is the mark down phase. This tends to be when the big guys start pulling out their money and so the prices can drop significantly in a matter of days. The pull out of investment can be for any reason, not necessarily due to the stocks performance, but can be due to change in big investors mindset or investment desire. When it is due to problems in the stock itself, it can signal to all the big guys to pull out which could be a total disaster for the individual investor, who can’t sell their stock to save themselves.
So to understand the phrase ‘what goes up must come down?’ Yes, the law of physics is true for stock prices too, but the problem is not so much that the stock is going up or down, it is more about the fact that you will never know which phase it is in and just when you buy a stock it could be right at the end of the ‘Distribution’ phase, signaling a ‘markdown’ phase about to happen. For individual investors, this is extremely difficult to determine and so though money can definitely be made during this time if you know what you are doing, it will be best advised to do your homework first before taking on any long term up trend stock.
For newbies to the stock market, it is best to not jump on long uptrend companies, mainly because lack of experience can be the worst thing when looking at graphs alone.
My advice: If you are a new or small time investor, stick with companies that are recovering from a downward trend, by measuring the % recovery from the years low. If it is between 30%-70%, you could be looking at a winner.