In general, why do stocks go up/down so much/drastically?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Topic Author
newbie003
Posts: 722
Joined: Thu Feb 02, 2017 9:25 am

In general, why do stocks go up/down so much/drastically?

Post by newbie003 »

I'm not exactly sure how to pose this question, and I may very well get slammed for it, but what I'm trying to get at is this; using MSFT as an example, but it really holds for anything (we could use COST, MCD, HD... essentially any 'real'/proven company, regardless of their business/business model), why does the stock move so much in a given day, week, year...? Also, fwiw, I meant to post this a while ago, not just now b/c markets are tumbling.

Of course I know that stocks are 'valued' in different ways; P/E ratio, peg ratio, etc... but what I don't get is why those valuations have any meaning (or are presumed to have meaning).

In other words, so what if MSFT or HD is supposed to earn (I'm making up #s here) $234 next year vs. $123 this year, or maybe only $99 next year vs $123 this year? Who cares if growth is slowing? Why should it matter if the P/E is 10, 15, 30 or 50? It has no real/actual effect on anything, correct? Or is there some real/actual difference/effect that I'm not understanding/thinking of if a company earns $100 million vs. $200 million vs. $50 million?

Or is it strictly supply and demand? If more people want to buy MSFT than sell, price goes up and vice versa? Again though, why would more people suddenly want to buy vs. sell given that the company is just going to keep going year after year? Why should it matter to anyone if MSFT makes $50, $100, $200, $75 per year? And using current markets as a further example, again, who cares if MSFT or COST or MCD won't make as much money in the coming years due to inflation, slowing growth or whatever other factors may affect their business? Does it really affect anything? Why would this make me want to sell my stock? I'm not going to lose money just because MSFT makes less profit next year (other than the stock going down which is my point of this whole topic). These companies aren't going bankrupt, they just aren't earning as much and, again, how does this affect anything?

Thanks for any comments and please don't beat me up to much... :)
toddthebod
Posts: 5741
Joined: Wed May 18, 2022 12:42 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by toddthebod »

It's fairly complicated, but I'll start with one simple aspect: there's a theory that the "correct" value of the stock is the discounted value of all future dividend payments. That theory explains why a bad quarterly report might trigger a massive sell-off. Consider Netflix: Investors may have extrapolated their growth rate and expected them to grow to a billion users. All of a sudden, they report having plateaued and even lost users at a quarter-billion. Now all those investors decide they were mistaken, the future is nowhere near as bright, and the company is re-valued by the market drastically downward.
jfave33
Posts: 3287
Joined: Thu Mar 19, 2015 6:18 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by jfave33 »

All I see is traders trying to profit off each other. Trying to get ahead of the news. Other than that the usual earnings reports, unexpected news, mergers etc. Wars, pandemics and other things that rattle the market or a section of it. Future outlook of the economy etc. Market sentiment.

You only have to look at gamestop to see how prices can be manipulated in all quarters
Last edited by jfave33 on Wed Jun 15, 2022 1:57 pm, edited 2 times in total.
invest4
Posts: 1905
Joined: Wed Apr 24, 2019 2:19 am

Re: In general, why do stocks go up/down so much/drastically?

Post by invest4 »

Fundamentally, people buy stocks based upon their expectations for performance. An individual stock may cost more or less relative to their earnings. Take Netflix for example, at some point people were paying $180 for each $1 of earnings. Netflix commanded this multiple because people thought they would eventually be rewarded for this bet. More recently, their results disappointed and people’s expectations changed and so they sell and look for somewhere else to invest in hopes of getting whatever return they are seeking.

Of course, it also works in the reverse. Apple was almost bankrupt at one point and could be bought very cheaply because expectations and P/E was very low. They dazzled and those people were richly rewarded for taking the risk.

One of the main reasons people do index investing is because we don’t know who will be the winners and losers…we simply accept the overall market result and adjust our AA to fit our overall risk appetite.
av111
Posts: 717
Joined: Mon Jan 26, 2015 12:27 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by av111 »

Stock prices have two parts

Current value based on the business
Future expectations

Usually current value can be range bound like MSFT will be within 15 to 20 times p/e

Future expectations are basically the casino, herd mentality or magic part of the pricing. Like If fed wants us to slow down, earnings will be smaller or fed will blink or Oh no sky is falling etc.
AV111
User avatar
btq96r
Posts: 556
Joined: Thu Dec 26, 2019 2:46 pm
Location: Nashville, TN

Re: In general, why do stocks go up/down so much/drastically?

Post by btq96r »

One of the best truisms I've heard is, "the stock market day to day is a reflection of rich people's feelings in real time." So, when you see huge day to day swings, that's all kinds of assumptions, doubt, and just plain overthinking that leads to big selling/buying swings. Over time (meaning years), you see a more complete picture removed from emotion. Time also culls the pack from the focus group from the greater fool theory.

It's honestly just a lot of hunches, assumptions, what is being paraded as risk management, and more. Best to just stick with the index funds on an established pattern of investing as able, not get caught up in the noise.
asif408
Posts: 2616
Joined: Sun Mar 02, 2014 7:34 am
Location: Florida

Re: In general, why do stocks go up/down so much/drastically?

Post by asif408 »

newbie003 wrote: Wed Jun 15, 2022 1:23 pm I'm not exactly sure how to pose this question, and I may very well get slammed for it, but what I'm trying to get at is this; using MSFT as an example, but it really holds for anything (we could use COST, MCD, HD... essentially any 'real'/proven company, regardless of their business/business model), why does the stock move so much in a given day, week, year...? Also, fwiw, I meant to post this a while ago, not just now b/c markets are tumbling.
Emotion and speculation mostly. Nothing that should concern a long-term investor.

newbie003 wrote: Wed Jun 15, 2022 1:23 pmOf course I know that stocks are 'valued' in different ways; P/E ratio, peg ratio, etc... but what I don't get is why those valuations have any meaning (or are presumed to have meaning).

In other words, so what if MSFT or HD is supposed to earn (I'm making up #s here) $234 next year vs. $123 this year, or maybe only $99 next year vs $123 this year? Who cares if growth is slowing? Why should it matter if the P/E is 10, 15, 30 or 50? It has no real/actual effect on anything, correct? Or is there some real/actual difference/effect that I'm not understanding/thinking of if a company earns $100 million vs. $200 million vs. $50 million?

Or is it strictly supply and demand? If more people want to buy MSFT than sell, price goes up and vice versa? Again though, why would more people suddenly want to buy vs. sell given that the company is just going to keep going year after year? Why should it matter to anyone if MSFT makes $50, $100, $200, $75 per year? And using current markets as a further example, again, who cares if MSFT or COST or MCD won't make as much money in the coming years due to inflation, slowing growth or whatever other factors may affect their business? Does it really affect anything? Why would this make me want to sell my stock? I'm not going to lose money just because MSFT makes less profit next year (other than the stock going down which is my point of this whole topic). These companies aren't going bankrupt, they just aren't earning as much and, again, how does this affect anything?
The price you pay matters because it tells you the expectations for the stock, sector, country, etc. which drives future returns. If you are paying a high price, whether it be high P/E, P/B, CAPE, P/CF, P/S, etc., expectations for the stock/sector/country are high, the stories around it are positive, generally the recent returns have been great, and future returns will likely be low (though no guarantee). On the other hand, if you are paying a low price for a stock/sector/country, expectations are low, the stories around it are negative, generally recent returns have been poor, and future returns should be high (again, no guarantee).

Here's a current example: right now, US tech stocks vs emerging market value stocks. Here are the 10 year returns from 2011-2021: https://www.portfoliovisualizer.com/bac ... ion2_2=100. Until the last few months, the stories around US tech were very positive, and their past returns were excellent. In contrast, EM value stocks have been through a decade of negative real returns (with 2 40% drops and a 30% drop during that stretch), there are concerns with China's crackdown on tech companies and potential conflict with Taiwan, Russia stocks recently stopped trading and effectively went to zero, etc. You get the picture, a negative one. And that is reflected in current valuations, EM value stocks trade at P/Es of around 5-10 with 5% dividend yields, vs. US tech stocks trading until recently at record high P/S ratios and elevated valuation ratios in pretty much every other valuation category, with a less than 1% dividend yield.

Since the start of this year, a different picture is evolving: https://www.portfoliovisualizer.com/bac ... ion2_2=100. This includes a time when Russian stocks effective went to zero. You will see many here say valuations don't matter, and that when the US sneezes the world catches a cold.

Valuations don't matter over short periods but history says eventually they do in the long run. I would argue you are seeing some of that play out now. You can see a similar dynamic in play with growth stocks vs value stocks worldwide.
Caduceus
Posts: 3527
Joined: Mon Sep 17, 2012 1:47 am

Re: In general, why do stocks go up/down so much/drastically?

Post by Caduceus »

I think the answer to your question is the "madness of crowds." Sometimes financial assets do get re-priced fairly rationally based on changes in available information. But oftentimes, there's a huge emotional and speculative element to short-term price movements. People get greedy or fearful, and there's a certain momentum to stocks that have experienced a huge run up or a huge decline. In the long run, the stock price will reflect the business fundamentals. But in the short run, herd psychology and the emotions of crowds means anything can happen.
Logan Roy
Posts: 1839
Joined: Sun May 29, 2022 10:15 am

Re: In general, why do stocks go up/down so much/drastically?

Post by Logan Roy »

For me, this Ben Graham quote describes it best:

“In the short run, the market is a voting machine, but in the long run it is a weighing machine.”

So metrics like PE, PB, P/FCF, etc. are extremely crude measures by today's standards. They're not *really* what analysts are valuing businesses on. The ability of a business to change its margins, while retaining a long-term competitive advantage, could drastically alter a PE ratio, and it's that business-level analysis any investor worth their salt should be doing or commissioning. And all these traders and analysts are seeing different parts of the same elephant – and information about those parts changes daily. So there's a lot of noise in the daily voting on prices. But it's the collective view that becomes 'efficient'. The wisdom of crowds.
User avatar
typical.investor
Posts: 5263
Joined: Mon Jun 11, 2018 3:17 am

Re: In general, why do stocks go up/down so much/drastically?

Post by typical.investor »

newbie003 wrote: Wed Jun 15, 2022 1:23 pm I'm not exactly sure how to pose this question, and I may very well get slammed for it, but what I'm trying to get at is this; using MSFT as an example, but it really holds for anything (we could use COST, MCD, HD... essentially any 'real'/proven company, regardless of their business/business model), why does the stock move so much in a given day, week, year...? Also, fwiw, I meant to post this a while ago, not just now b/c markets are tumbling.

Of course I know that stocks are 'valued' in different ways; P/E ratio, peg ratio, etc... but what I don't get is why those valuations have any meaning (or are presumed to have meaning).

In other words, so what if MSFT or HD is supposed to earn (I'm making up #s here) $234 next year vs. $123 this year, or maybe only $99 next year vs $123 this year? Who cares if growth is slowing? Why should it matter if the P/E is 10, 15, 30 or 50? It has no real/actual effect on anything, correct? Or is there some real/actual difference/effect that I'm not understanding/thinking of if a company earns $100 million vs. $200 million vs. $50 million?

Or is it strictly supply and demand? If more people want to buy MSFT than sell, price goes up and vice versa? Again though, why would more people suddenly want to buy vs. sell given that the company is just going to keep going year after year? Why should it matter to anyone if MSFT makes $50, $100, $200, $75 per year? And using current markets as a further example, again, who cares if MSFT or COST or MCD won't make as much money in the coming years due to inflation, slowing growth or whatever other factors may affect their business? Does it really affect anything? Why would this make me want to sell my stock? I'm not going to lose money just because MSFT makes less profit next year (other than the stock going down which is my point of this whole topic). These companies aren't going bankrupt, they just aren't earning as much and, again, how does this affect anything?

Thanks for any comments and please don't beat me up to much... :)
Leverage. If the economy is good and the market is going up many will leverage to boost returns which will generally raise prices. When things sour, deleveraging happens and prices drop not only from whatever economic troubles there may be, but also from the removal of leverage.


And then you can add in short sellers in a downturn which creases the number of sellers and generally pushes the price down. And leveraged short sellers too!!!
invest2bfree
Posts: 1279
Joined: Sun Jan 12, 2020 8:44 am

Re: In general, why do stocks go up/down so much/drastically?

Post by invest2bfree »

newbie003 wrote: Wed Jun 15, 2022 1:23 pm I'm not exactly sure how to pose this question, and I may very well get slammed for it, but what I'm trying to get at is this; using MSFT as an example, but it really holds for anything (we could use COST, MCD, HD... essentially any 'real'/proven company, regardless of their business/business model), why does the stock move so much in a given day, week, year...? Also, fwiw, I meant to post this a while ago, not just now b/c markets are tumbling.

Of course I know that stocks are 'valued' in different ways; P/E ratio, peg ratio, etc... but what I don't get is why those valuations have any meaning (or are presumed to have meaning).

In other words, so what if MSFT or HD is supposed to earn (I'm making up #s here) $234 next year vs. $123 this year, or maybe only $99 next year vs $123 this year? Who cares if growth is slowing? Why should it matter if the P/E is 10, 15, 30 or 50? It has no real/actual effect on anything, correct? Or is there some real/actual difference/effect that I'm not understanding/thinking of if a company earns $100 million vs. $200 million vs. $50 million?

Or is it strictly supply and demand? If more people want to buy MSFT than sell, price goes up and vice versa? Again though, why would more people suddenly want to buy vs. sell given that the company is just going to keep going year after year? Why should it matter to anyone if MSFT makes $50, $100, $200, $75 per year? And using current markets as a further example, again, who cares if MSFT or COST or MCD won't make as much money in the coming years due to inflation, slowing growth or whatever other factors may affect their business? Does it really affect anything? Why would this make me want to sell my stock? I'm not going to lose money just because MSFT makes less profit next year (other than the stock going down which is my point of this whole topic). These companies aren't going bankrupt, they just aren't earning as much and, again, how does this affect anything?

Thanks for any comments and please don't beat me up to much... :)
Discount the earnings with the BAA yield then you will get the actual value.


https://fred.stlouisfed.org/series/BAA

https://www.multpl.com/s-p-500-earnings/table/by-year


S&P 500 = 200/0.052 = 3856.
36% (IRA) - Individual LT Corporate Bonds , 33%(taxable) - schy, 33%(taxable) - SCHD Dividend Growth
valleyrock
Posts: 1129
Joined: Sun Aug 12, 2018 7:12 am

Re: In general, why do stocks go up/down so much/drastically?

Post by valleyrock »

Herd mentality.
IDpilot
Posts: 274
Joined: Sat Dec 05, 2020 7:13 am

Re: In general, why do stocks go up/down so much/drastically?

Post by IDpilot »

I think James Grant said it best,

To suppose that the value of a common stock is determined purely by a corporation’s earnings discounted by the relevant interest rates and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin and believed Orson Welles when he told them over the radio that the Martians had landed.
Northern Flicker
Posts: 15371
Joined: Fri Apr 10, 2015 12:29 am

Re: In general, why do stocks go up/down so much/drastically?

Post by Northern Flicker »

IDpilot wrote: Sat Jun 25, 2022 9:48 pm I think James Grant said it best,

To suppose that the value of a common stock is determined purely by a corporation’s earnings discounted by the relevant interest rates and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin and believed Orson Welles when he told them over the radio that the Martians had landed.
These are not mutually inconsistent. If investors believe the Martians have landed, they will try to estimate how that will effect future revenue of a company, and then discount it back to a present value.

The future revenue of a company is unknown. Every day the state of the world changes, and the consensus view of the future revenue of a company changes.

That said, I don’t have a dog in this fight. Discounted cash flows or investor behavior/emotion or something else or all of that put together well may be true, but I don’t think the correct position can be established, and it has no impact on my investment strategy.
gougou
Posts: 1317
Joined: Thu Sep 28, 2017 7:42 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by gougou »

Nobody calculates some discounted cash flow when buying/selling stocks, including pretty much everyone on this board.

Mr. Market is emotional, euphoric, moody and often irrational. Sometimes it can push the market or certain stocks to irrationally low/high levels due to fear/herd mentality. Even if the stock is undervalued by 50% or overvalued by 500%, you still can’t reliably expect to beat the market by taking the opposite position. The fundamental strength of the companies only drive very long term returns.
The sillier the market’s behavior, the greater the opportunity for the business like investor.
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: In general, why do stocks go up/down so much/drastically?

Post by dbr »

I'm not usually one for quips, but in this case there is one that might apply -- fear and greed.
scout1
Posts: 234
Joined: Thu Oct 18, 2018 3:26 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by scout1 »

I don’t understand why people aren’t saying FUNDAMENTALS. Stocks are valued as perpetuities. Small change makes a big difference when they are expected to last an infinite number of years. A change of 1% to the growth rate or the discount rate of a perpetuity is huge, especially when rates are fairly low. Long term growth and discount rates are always being updated with new info. Also have you seen what rates have done recently?

If the answer was emotion, someone could beat the market by just buying undervalued companies and shorting overvalued companies and beat the market. “The market can remain irrational longer than you can remain solvent” doesn’t apply if you don’t make large bets. Since no one can beat the market, the answer is clearly fundamentals.
MathWizard
Posts: 6561
Joined: Tue Jul 26, 2011 1:35 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by MathWizard »

typical.investor wrote: Thu Jun 16, 2022 8:26 am
newbie003 wrote: Wed Jun 15, 2022 1:23 pm I'm not exactly sure how to pose this question, and I may very well get slammed for it, but what I'm trying to get at is this; using MSFT as an example, but it really holds for anything (we could use COST, MCD, HD... essentially any 'real'/proven company, regardless of their business/business model), why does the stock move so much in a given day, week, year...? Also, fwiw, I meant to post this a while ago, not just now b/c markets are tumbling.

Of course I know that stocks are 'valued' in different ways; P/E ratio, peg ratio, etc... but what I don't get is why those valuations have any meaning (or are presumed to have meaning).

In other words, so what if MSFT or HD is supposed to earn (I'm making up #s here) $234 next year vs. $123 this year, or maybe only $99 next year vs $123 this year? Who cares if growth is slowing? Why should it matter if the P/E is 10, 15, 30 or 50? It has no real/actual effect on anything, correct? Or is there some real/actual difference/effect that I'm not understanding/thinking of if a company earns $100 million vs. $200 million vs. $50 million?

Or is it strictly supply and demand? If more people want to buy MSFT than sell, price goes up and vice versa? Again though, why would more people suddenly want to buy vs. sell given that the company is just going to keep going year after year? Why should it matter to anyone if MSFT makes $50, $100, $200, $75 per year? And using current markets as a further example, again, who cares if MSFT or COST or MCD won't make as much money in the coming years due to inflation, slowing growth or whatever other factors may affect their business? Does it really affect anything? Why would this make me want to sell my stock? I'm not going to lose money just because MSFT makes less profit next year (other than the stock going down which is my point of this whole topic). These companies aren't going bankrupt, they just aren't earning as much and, again, how does this affect anything?

Thanks for any comments and please don't beat me up to much... :)
Leverage. If the economy is good and the market is going up many will leverage to boost returns which will generally raise prices. When things sour, deleveraging happens and prices drop not only from whatever economic troubles there may be, but also from the removal of leverage.


And then you can add in short sellers in a downturn which creases the number of sellers and generally pushes the price down. And leveraged short sellers too!!!
Yes, leverage is the accelerant in either direction.
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: In general, why do stocks go up/down so much/drastically?

Post by dbr »

scout1 wrote: Sun Jun 26, 2022 10:05 am I don’t understand why people aren’t saying FUNDAMENTALS. Stocks are valued as perpetuities. Small change makes a big difference when they are expected to last an infinite number of years. A change of 1% to the growth rate or the discount rate of a perpetuity is huge, especially when rates are fairly low. Long term growth and discount rates are always being updated with new info. Also have you seen what rates have done recently?

If the answer was emotion, someone could beat the market by just buying undervalued companies and shorting overvalued companies and beat the market. “The market can remain irrational longer than you can remain solvent” doesn’t apply if you don’t make large bets. Since no one can beat the market, the answer is clearly fundamentals.
This does have an appealing logic. That a response is an amplification of noise does explain why the response becomes a very loud noise.
User avatar
nedsaid
Posts: 19275
Joined: Fri Nov 23, 2012 11:33 am

Re: In general, why do stocks go up/down so much/drastically?

Post by nedsaid »

In general, stocks are volatile because underlying earnings can be volatile. Also, investor enthusiasm for stocks can be volatile as well.
A fool and his money are good for business.
Hatch Batten
Posts: 101
Joined: Tue Feb 22, 2011 8:45 pm
Location: Portland, OR
Contact:

Re: In general, why do stocks go up/down so much/drastically?

Post by Hatch Batten »

Paraphrased, I'm reading your question as "why do stock values fluctuate in response to changes in earnings for the underlying companies?" And, as a caveat, you said that you're specifically interested in companies at minimal risk of going out of business.

Let's say XYZ Widgets Incorporated earned $10 million in the first quarter and $20 million in the second quarter. Its stock rises after the Q2 earnings report. Why might that be?

Those earnings represent real money in the company coffers. They can use it do a number of things that may please investors:

- invest in their operations to expand their market, or improve their profitability
- acquire a competitor
- acquire a new line of business
- raise their dividend
- buy back some of their stock (which pressures the remaining public shares to move higher)

If, by contrast, their earnings had dipped to $5 million in the second quarter, they'd be less likely to undertake any of the above actions.

Put another way, owning a share of a company means that you should be interested in how the company's cash flow fluctuates. Investors expect a piece of the company's cash flow to accrue to their stock holding, whether through dividends or through share price appreciation. When cash flow rises, the shares tend to be valued higher. When cash flow drops, the shares tend to be valued lower.

There are other factors than price, of course. I think quality of management is a big one. And certainly there have been companies that reach a certain level of profitability and experience a cultural change from innovator to 'cash cow'. Their dividend may grow, but their price appreciation slows or stops altogether. I worked at Disney for a couple of years during a long stretch like this where they were still making a lot of money but their innovation culture had plateaued and their acquisitions rarely panned out.
billaster
Posts: 2932
Joined: Wed Apr 27, 2022 2:21 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by billaster »

Part of Robert Shiller's economics Nobel prize was about the observation that stock prices are much more volatile than the efficient market hypothesis would explain. His work suggests that behavioral effects, popular opinion and psychology, cause markets to behave irrationally, causing markets to swing much more than would be explained by the efficient incorporation of information. His work indicates that markets are much less efficient than often assumed and that is "why stock go up/down so much/drastically."
Mister A
Posts: 155
Joined: Tue Oct 21, 2014 4:17 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by Mister A »

newbie003 wrote: Wed Jun 15, 2022 1:23 pmAgain though, why would more people suddenly want to buy vs. sell given that the company is just going to keep going year after year? Why should it matter to anyone if MSFT makes $50, $100, $200, $75 per year? And using current markets as a further example, again, who cares if MSFT or COST or MCD won't make as much money in the coming years due to inflation, slowing growth or whatever other factors may affect their business? Does it really affect anything? Why would this make me want to sell my stock? I'm not going to lose money just because MSFT makes less profit next year (other than the stock going down which is my point of this whole topic). These companies aren't going bankrupt, they just aren't earning as much and, again, how does this affect anything?
You're getting lots of good and interesting answers - all accurate from different angles - but I want to address "who cares" specifically.

At the most basic level, if I own a car wash, it is not important that I do not take a cash draw from the profits. Upon learning that my car wash is likely to make less money in the coming years, my car wash is worth less to a potential buyer because of the assets that are likely to (not) be contained within it in the future. It is also worth less to a potential lender who might want to use it as collateral.

This has relatively little immediate impact on me, but if I'm not taking a cash draw, why do I own the car wash? Probably not because I really like to watch cars get washed. It's probably for eventual sale. Today's price fluctuations on new information about the business and market conditions don't mean a lot to me today, but they will, eventually, and they do to people who are considering making an offer on a car wash (including, potentially, mine).

The cash contained within the business - now and in five years - is absolutely critical information to a prospective buyer, and that's what a share price represents - what people are paying, right now, for a small piece of ownership.

Now, if I do take a cash draw (receive a dividend), that's great. That is a purpose beyond the share price. The shares, however, are still an asset that has to be valued at some point - I will not live forever, and my beneficiaries are likely to want to sell - and even the question of whether or not the company will be able to continue paying that cash draw in the future matters.

It may not necessarily "make you want to sell" to see share price decline, but the future success of the company, not just it's mere existence, is absolutely meaningful to understanding the value of owning those shares. Holding through a decline is essentially a statement that you believe there is additional information that makes ownership of this stock more valuable to you than the cash you would receive at the current price. As you say, supply and demand. Market forces turn on a meeting of the minds between you and the next guy.
Goldwater85
Posts: 241
Joined: Fri Nov 22, 2019 6:00 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by Goldwater85 »

If you think of stocks as equivalent to completely subordinated, unsecured junk bonds with 1,000 years duration, that gets you about 80% of the way there.
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: In general, why do stocks go up/down so much/drastically?

Post by dbr »

I suppose there could be a list of other assets that have large price volatility. I don't know the numbers on these various economic items:

Real Estate
Gold
Oil
Art
Frozen Hog Bellies
Interest Rates (Note the measure here is not units percent change but relative change -- 1% >> 2% is a 100% change.)
av111
Posts: 717
Joined: Mon Jan 26, 2015 12:27 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by av111 »

asif408 wrote: Wed Jun 15, 2022 2:15 pm
newbie003 wrote: Wed Jun 15, 2022 1:23 pm I'm not exactly sure how to pose this question, and I may very well get slammed for it, but what I'm trying to get at is this; using MSFT as an example, but it really holds for anything (we could use COST, MCD, HD... essentially any 'real'/proven company, regardless of their business/business model), why does the stock move so much in a given day, week, year...? Also, fwiw, I meant to post this a while ago, not just now b/c markets are tumbling.
Emotion and speculation mostly. Nothing that should concern a long-term investor.

newbie003 wrote: Wed Jun 15, 2022 1:23 pmOf course I know that stocks are 'valued' in different ways; P/E ratio, peg ratio, etc... but what I don't get is why those valuations have any meaning (or are presumed to have meaning).

In other words, so what if MSFT or HD is supposed to earn (I'm making up #s here) $234 next year vs. $123 this year, or maybe only $99 next year vs $123 this year? Who cares if growth is slowing? Why should it matter if the P/E is 10, 15, 30 or 50? It has no real/actual effect on anything, correct? Or is there some real/actual difference/effect that I'm not understanding/thinking of if a company earns $100 million vs. $200 million vs. $50 million?

Or is it strictly supply and demand? If more people want to buy MSFT than sell, price goes up and vice versa? Again though, why would more people suddenly want to buy vs. sell given that the company is just going to keep going year after year? Why should it matter to anyone if MSFT makes $50, $100, $200, $75 per year? And using current markets as a further example, again, who cares if MSFT or COST or MCD won't make as much money in the coming years due to inflation, slowing growth or whatever other factors may affect their business? Does it really affect anything? Why would this make me want to sell my stock? I'm not going to lose money just because MSFT makes less profit next year (other than the stock going down which is my point of this whole topic). These companies aren't going bankrupt, they just aren't earning as much and, again, how does this affect anything?
The price you pay matters because it tells you the expectations for the stock, sector, country, etc. which drives future returns. If you are paying a high price, whether it be high P/E, P/B, CAPE, P/CF, P/S, etc., expectations for the stock/sector/country are high, the stories around it are positive, generally the recent returns have been great, and future returns will likely be low (though no guarantee). On the other hand, if you are paying a low price for a stock/sector/country, expectations are low, the stories around it are negative, generally recent returns have been poor, and future returns should be high (again, no guarantee).

Here's a current example: right now, US tech stocks vs emerging market value stocks. Here are the 10 year returns from 2011-2021: https://www.portfoliovisualizer.com/bac ... ion2_2=100. Until the last few months, the stories around US tech were very positive, and their past returns were excellent. In contrast, EM value stocks have been through a decade of negative real returns (with 2 40% drops and a 30% drop during that stretch), there are concerns with China's crackdown on tech companies and potential conflict with Taiwan, Russia stocks recently stopped trading and effectively went to zero, etc. You get the picture, a negative one. And that is reflected in current valuations, EM value stocks trade at P/Es of around 5-10 with 5% dividend yields, vs. US tech stocks trading until recently at record high P/S ratios and elevated valuation ratios in pretty much every other valuation category, with a less than 1% dividend yield.

Since the start of this year, a different picture is evolving: https://www.portfoliovisualizer.com/bac ... ion2_2=100. This includes a time when Russian stocks effective went to zero. You will see many here say valuations don't matter, and that when the US sneezes the world catches a cold.

Valuations don't matter over short periods but history says eventually they do in the long run. I would argue you are seeing some of that play out now. You can see a similar dynamic in play with growth stocks vs value stocks worldwide.
If expectations is the driver why do we say algorithm trading causes these periods of volatility? Specifically what rules would an algorithm implement to buy or sell
AV111
User avatar
David Jay
Posts: 14587
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: In general, why do stocks go up/down so much/drastically?

Post by David Jay »

av111 wrote: Sun Jun 26, 2022 12:52 pmIf expectations is the driver why do we say algorithm trading causes these periods of volatility? Specifically what rules would an algorithm implement to buy or sell
Some programmed trading actually uses key-words from news bulletins.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
HootingSloth
Posts: 1050
Joined: Mon Jan 28, 2019 2:38 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by HootingSloth »

I always thought this blog post by economist John Cochrane from 2018 did a nice job. Here is one short excerpt, but reading the whole thing would be much better:
Stock prices are very sensitive to real interest rates, risk premiums, and growth expectations. At our current P/D of 40, for example, this means r−g = 1/40 = 0.025 or 2.5%. Just half a percent change in expected return or growth rate, r-g = 0.02 would mean P/D = 1/0.02 = 50, a 25% rise in stock prices. Conversely, a half percent rise in real interest rates would mean r-g = 0.03, a decline to P/D = 33 a 16.7% fall. No wonder stocks are (usually) volatile!
Global Market Portfolio + modest tilt towards volatility (80/20->60/40 as approach FI) + modest tilt away from exchange rate risk (80% global+20% U.S. stocks; currency-hedge bonds) + tax optimization
tvubpwcisla
Posts: 1167
Joined: Sat Nov 09, 2019 9:09 am

Re: In general, why do stocks go up/down so much/drastically?

Post by tvubpwcisla »

Emotions (fear and greed).
Northern Flicker
Posts: 15371
Joined: Fri Apr 10, 2015 12:29 am

Re: In general, why do stocks go up/down so much/drastically?

Post by Northern Flicker »

gougou wrote: Sat Jun 25, 2022 11:37 pm Nobody calculates some discounted cash flow when buying/selling stocks, including pretty much everyone on this board.
If you are referring to amateur retail investors, that is likely true. For active institutional investors who drive market pricing for most stocks, your statement is false.
User avatar
firebirdparts
Posts: 4415
Joined: Thu Jun 13, 2019 4:21 pm
Location: Southern Appalachia

Re: In general, why do stocks go up/down so much/drastically?

Post by firebirdparts »

You know, what’s shocking in this is that stocks really go up and down very little compared to how they did it in “the old days”. Market regulations reduced dramatically the amount of outright manipulation and also standardized financial reporting. This is really the boring version.
This time is the same
gougou
Posts: 1317
Joined: Thu Sep 28, 2017 7:42 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by gougou »

Northern Flicker wrote: Sun Jun 26, 2022 1:52 pm
gougou wrote: Sat Jun 25, 2022 11:37 pm Nobody calculates some discounted cash flow when buying/selling stocks, including pretty much everyone on this board.
If you are referring to amateur retail investors, that is likely true. For active institutional investors who drive market pricing for most stocks, your statement is false.
The institutions don’t either. If you worked in some you’ll know. The quantitative firms look at so many signals but not discounted cash flow. Even value investors who look at fundamentals don’t calculate discounted cash flow. To think that market revolves around discounted cash flow is pure daydreaming.
The sillier the market’s behavior, the greater the opportunity for the business like investor.
User avatar
PicassoSparks
Posts: 417
Joined: Tue Apr 28, 2020 5:41 am

Re: In general, why do stocks go up/down so much/drastically?

Post by PicassoSparks »

av111 wrote: Sun Jun 26, 2022 12:52 pm If expectations is the driver why do we say algorithm trading causes these periods of volatility? Specifically what rules would an algorithm implement to buy or sell
At the core, the expectations are the driver but it is a slow return on your investment with a lot of uncertainty and a high degree of sensitivity to small changes as others have mentioned. The price discovery of the market is the aggregate wisdom of many players, all of whom think they have some good ideas about the future and all of their ideas are different. Most of them are wrong, but in aggregate, we find the equilibrium price. Remember, at the price, there are some number of actors who think they are getting an incredible deal by buying for much less than they’d be willing to spend and some other number who think they are getting a deal by selling for more than they’d be willing to accept. And a huge pile of actors who think the price is too high to buy or too low to sell.

Into this dynamic, you add people who think “hey, what if I don’t need to be right about the next 20 years, just the next 20 days? If I have information that makes me think the stock will go up tomorrow, because it will improve ghe 20 year prospects, I can buy it today!” But they are also a mix of right and wrong because everyone has incomplete information. And then you repeat that down to the next 20 hours, next 20 minutes, next 20 seconds, right down to the physical limits of information processing and the speed of light. But to trade at that speed, you need superhuman reflexes, which means algorithms and computers.

All these different games at all these different time scales are operating at the same time, on the same playing field.
Northern Flicker
Posts: 15371
Joined: Fri Apr 10, 2015 12:29 am

Re: In general, why do stocks go up/down so much/drastically?

Post by Northern Flicker »

gougou wrote: Sun Jun 26, 2022 2:13 pm
Northern Flicker wrote: Sun Jun 26, 2022 1:52 pm
gougou wrote: Sat Jun 25, 2022 11:37 pm Nobody calculates some discounted cash flow when buying/selling stocks, including pretty much everyone on this board.
If you are referring to amateur retail investors, that is likely true. For active institutional investors who drive market pricing for most stocks, your statement is false.
The institutions don’t either. If you worked in some you’ll know. The quantitative firms look at so many signals but not discounted cash flow. Even value investors who look at fundamentals don’t calculate discounted cash flow. To think that market revolves around discounted cash flow is pure daydreaming.
What is a forward P/E multiple, and how would you decide if a given P/E is fair value at any given moment in time?

Buying stocks based on dividend yield also would be implicitly valuing them by a discounted dividend model.
Last edited by Northern Flicker on Sun Jun 26, 2022 3:25 pm, edited 1 time in total.
gougou
Posts: 1317
Joined: Thu Sep 28, 2017 7:42 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by gougou »

Northern Flicker wrote: Sun Jun 26, 2022 3:14 pm
gougou wrote: Sun Jun 26, 2022 2:13 pm
Northern Flicker wrote: Sun Jun 26, 2022 1:52 pm
gougou wrote: Sat Jun 25, 2022 11:37 pm Nobody calculates some discounted cash flow when buying/selling stocks, including pretty much everyone on this board.
If you are referring to amateur retail investors, that is likely true. For active institutional investors who drive market pricing for most stocks, your statement is false.
The institutions don’t either. If you worked in some you’ll know. The quantitative firms look at so many signals but not discounted cash flow. Even value investors who look at fundamentals don’t calculate discounted cash flow. To think that market revolves around discounted cash flow is pure daydreaming.
What is a forward P/E multiple?
It’s not discounted cash flow.
The sillier the market’s behavior, the greater the opportunity for the business like investor.
Northern Flicker
Posts: 15371
Joined: Fri Apr 10, 2015 12:29 am

Re: In general, why do stocks go up/down so much/drastically?

Post by Northern Flicker »

How you can decide if a P/E is fair value at a moment in time depends on interest rates and the discount rate for the forward earnings.
gougou
Posts: 1317
Joined: Thu Sep 28, 2017 7:42 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by gougou »

Northern Flicker wrote: Sun Jun 26, 2022 3:26 pm How you can decide if a P/E is fair value at a moment in time depends on interest rates and the discount rate for the forward earnings.
The E in P/E is not a cash measure. So it has little to do with cashflow or discounted cashflow.
The sillier the market’s behavior, the greater the opportunity for the business like investor.
Jags4186
Posts: 8198
Joined: Wed Jun 18, 2014 7:12 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by Jags4186 »

The price is set 100% by supply and demand. If there are more sellers than buyers the price will drop until an equilibrium is reached. Same if there are more buyers and sellers.

The reason why there would be that situation could be plentiful — an individual company underperformed/overperformed prior guidance and increases future guidance could be a reason a stock spikes. Simply the expectation that a company will make lots of money in the future is enough to drive the price up wildly (Tesla). Market sentiments as a whole can drive a stock higher or lower—if the sentiment around technology is low so all tech stocks drop—or not increase as expected—regardless of their individual performance. Stocks can move up and down completely irrationally.
Logan Roy
Posts: 1839
Joined: Sun May 29, 2022 10:15 am

Re: In general, why do stocks go up/down so much/drastically?

Post by Logan Roy »

Early in his trading life, Stan Druckenmiller was posed the question: what makes stocks go up and down? He went away and worked on the problem, and came back with the intended answer: liquidity. (obv. stocks can front-run liquidity, as the Fed's quite good at signalling its intent.)

Image

The old adage is that 40% of a stock's move is the market; 20% the sector; 20% the business. So another old trading saying is that everything is ultimately a bet on inflation (as if you know where inflation's going, you've got a pretty good idea where policy's going).

I'd say discounted future cashflows are a useful concept when interpreting the scale of moves between growth and value stocks this year. A very large part of what's taken growth down is that these stocks behave like longer-duration assets (despite stocks being infinite duration, of course), while value behaves more like short duration. So it's really just mirrored what's happened in bond markets as assumptions about the rates path are priced in.
Northern Flicker
Posts: 15371
Joined: Fri Apr 10, 2015 12:29 am

Re: In general, why do stocks go up/down so much/drastically?

Post by Northern Flicker »

gougou wrote: Sun Jun 26, 2022 3:33 pm
Northern Flicker wrote: Sun Jun 26, 2022 3:26 pm How you can decide if a P/E is fair value at a moment in time depends on interest rates and the discount rate for the forward earnings.
The E in P/E is not a cash measure. So it has little to do with cashflow or discounted cashflow.
Do you buy stocks that earn revenue in bitcoins instead of cash?
Northern Flicker
Posts: 15371
Joined: Fri Apr 10, 2015 12:29 am

Re: In general, why do stocks go up/down so much/drastically?

Post by Northern Flicker »

Jags4186 wrote: Sun Jun 26, 2022 3:42 pm The price is set 100% by supply and demand. If there are more sellers than buyers the price will drop until an equilibrium is reached. Same if there are more buyers and sellers.
Certainly. And buyers and sellers who are active managers or traders decide to buy or sell based on some perception or analysis of the worth of the stock being bought or sold.
av111
Posts: 717
Joined: Mon Jan 26, 2015 12:27 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by av111 »

PicassoSparks wrote: Sun Jun 26, 2022 2:58 pm
av111 wrote: Sun Jun 26, 2022 12:52 pm If expectations is the driver why do we say algorithm trading causes these periods of volatility? Specifically what rules would an algorithm implement to buy or sell
At the core, the expectations are the driver but it is a slow return on your investment with a lot of uncertainty and a high degree of sensitivity to small changes as others have mentioned. The price discovery of the market is the aggregate wisdom of many players, all of whom think they have some good ideas about the future and all of their ideas are different. Most of them are wrong, but in aggregate, we find the equilibrium price. Remember, at the price, there are some number of actors who think they are getting an incredible deal by buying for much less than they’d be willing to spend and some other number who think they are getting a deal by selling for more than they’d be willing to accept. And a huge pile of actors who think the price is too high to buy or too low to sell.

Into this dynamic, you add people who think “hey, what if I don’t need to be right about the next 20 years, just the next 20 days? If I have information that makes me think the stock will go up tomorrow, because it will improve ghe 20 year prospects, I can buy it today!” But they are also a mix of right and wrong because everyone has incomplete information. And then you repeat that down to the next 20 hours, next 20 minutes, next 20 seconds, right down to the physical limits of information processing and the speed of light. But to trade at that speed, you need superhuman reflexes, which means algorithms and computers.

All these different games at all these different time scales are operating at the same time, on the same playing field.
I get what you are saying and see it in the retail trading but what about algorithmic trading? Big trades can't be retail in general so some rules based programs are making these trades. I think these would be 20 minute duration trades not 20 days or 20 years

I am curious about the metrics that program would use.. Order flow, volume?
AV111
Logan Roy
Posts: 1839
Joined: Sun May 29, 2022 10:15 am

Re: In general, why do stocks go up/down so much/drastically?

Post by Logan Roy »

av111 wrote: Sun Jun 26, 2022 4:52 pm
PicassoSparks wrote: Sun Jun 26, 2022 2:58 pm
av111 wrote: Sun Jun 26, 2022 12:52 pm If expectations is the driver why do we say algorithm trading causes these periods of volatility? Specifically what rules would an algorithm implement to buy or sell
At the core, the expectations are the driver but it is a slow return on your investment with a lot of uncertainty and a high degree of sensitivity to small changes as others have mentioned. The price discovery of the market is the aggregate wisdom of many players, all of whom think they have some good ideas about the future and all of their ideas are different. Most of them are wrong, but in aggregate, we find the equilibrium price. Remember, at the price, there are some number of actors who think they are getting an incredible deal by buying for much less than they’d be willing to spend and some other number who think they are getting a deal by selling for more than they’d be willing to accept. And a huge pile of actors who think the price is too high to buy or too low to sell.

Into this dynamic, you add people who think “hey, what if I don’t need to be right about the next 20 years, just the next 20 days? If I have information that makes me think the stock will go up tomorrow, because it will improve ghe 20 year prospects, I can buy it today!” But they are also a mix of right and wrong because everyone has incomplete information. And then you repeat that down to the next 20 hours, next 20 minutes, next 20 seconds, right down to the physical limits of information processing and the speed of light. But to trade at that speed, you need superhuman reflexes, which means algorithms and computers.

All these different games at all these different time scales are operating at the same time, on the same playing field.
I get what you are saying and see it in the retail trading but what about algorithmic trading? Big trades can't be retail in general so some rules based programs are making these trades. I think these would be 20 minute duration trades not 20 days or 20 years

I am curious about the metrics that program would use.. Order flow, volume?
Just to jump in from my own experience. Stocks are most comprehensively valued by analysts and analyst firms. And much of what goes into a valuation wouldn't be described as 'quantitative'. Metrics are rather crude ways to rank businesses. What an analyst has to do is look at a business as a whole, and in the context of its sector, and its market, and work out how much it might be worth in 15-30 years. And this has changed a lot. Firms employ academics to look at the potential value of a firm's intellectual property (what value can we put on a certain new battery design?), or its brand value, or they'll use satellites to look at traffic flow in a business' carparks.

Big, slow institutional investors will be making decisions typically based on this kind of analysis. And making decisions on asset allocation – so discounted cash-flows of stocks vs bonds are a very real part of how the market expresses demand. Then you get high frequency traders (usually hedge funds) which account for at least a third of all trades (I believe), doing things like latency arbitrage. Then you get hedge fund strategies like statistical arbitrage and trend following (closing much smaller gaps in market inefficiency). Then you might get to the fundamentals-weighted ETFs and quant funds. But seemingly in the UK, these are not very big parts of the market. But all in all, this work is what makes markets efficient, and ensures capital is directed to the right places.
WhyNotUs
Posts: 2610
Joined: Sun Apr 14, 2013 11:38 am

Re: In general, why do stocks go up/down so much/drastically?

Post by WhyNotUs »

A majority of stock trades are by algorithms with proprietary logic systems determining trading action. There are momentum programs that trade on increases and magnify price increases. There are stop programs that try to minimize losses by getting out when a stock starts to drop. There are programs that play both moves. There are countless other varieties of algorithms that we do not know about but in general, I would say that they play fear and greed for optimal gain.

It humors me when headlines on Yahoo or similar try to explain stock price changes to something in the days news. Sometimes they have to change the headline mid-day as the programs shift trades and people follow along. It would be funny if it were not my retirement money. I long for an alternative passive and diverse way to fund my retirement.
I own the next hot stock- VTSAX
Nowizard
Posts: 4842
Joined: Tue Oct 23, 2007 5:33 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by Nowizard »

I suspect part of it is behavioral psychology and that decisions drastically affecting the market are caused or partially correlated with the degree of uncertainty existing in the market. I suspect another factor is the Internet and the availability of instant information. People become immediately aware of algorithms and comments about, for example, resistance levels that reflect up or down for future market directions and respond, including institutional investors. If market direction is focused on the future and what is going to happen, it taps into positive and negative expectations and anxiety. Anxiety lies in the future related to the question of "What is going to happen?" Since there is no certain answer with any very complex topic, there are very differing interpretations by different people including investors and those whose acts influence those of us looking for direction. Add these factors to the best analyses available based on economic studies, and you still have uncertainty combined with the necessity of acting in spite of it. For many here, that action is doing little or nothing during times of the greatest uncertainty.

Tim
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: In general, why do stocks go up/down so much/drastically?

Post by dbr »

Nowizard wrote: Mon Jun 27, 2022 8:43 am I suspect part of it is behavioral psychology and that decisions drastically affecting the market are caused or partially correlated with the degree of uncertainty existing in the market. I suspect another factor is the Internet and the availability of instant information. People become immediately aware of algorithms and comments about, for example, resistance levels that reflect up or down for future market directions and respond, including institutional investors. If market direction is focused on the future and what is going to happen, it taps into positive and negative expectations and anxiety. Anxiety lies in the future related to the question of "What is going to happen?" Since there is no certain answer with any very complex topic, there are very differing interpretations by different people including investors and those whose acts influence those of us looking for direction. Add these factors to the best analyses available based on economic studies, and you still have uncertainty combined with the necessity of acting in spite of it. For many here, that action is doing little or nothing during times of the greatest uncertainty.

Tim
I think along these lines as well. That is why my approach is to look at stocks as happenstance variability and expect unpredictable volatility. It is also why I would have no temptation to time the market or attempt charting or something like that. Taking a long run view helps a lot.
User avatar
nisiprius
Advisory Board
Posts: 52219
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: In general, why do stocks go up/down so much/drastically?

Post by nisiprius »

Logan Roy wrote: Thu Jun 16, 2022 5:55 am For me, this Ben Graham quote describes it best:

“In the short run, the market is a voting machine, but in the long run it is a weighing machine.”
He probably didn't say that.

He wrote, both in Security Analysis and in The Intelligent Investor that "The stock market is a voting machine rather than a weighing machine."

He didn't write "short term" and he didn't write that it is a weighing machine in the long term. He just says it isn't a weighing machine. Period.

Jason Zweig dug into this a while back, doesn't think "weighing machine in the long run" appears in any of his published writing, and couldn't find any evidence for except Warren Buffett remembering it that way.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
alex_686
Posts: 13320
Joined: Mon Feb 09, 2015 1:39 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by alex_686 »

Nowizard wrote: Mon Jun 27, 2022 8:43 am I suspect part of it is behavioral psychology and that decisions drastically affecting the market are caused or partially correlated with the degree of uncertainty existing in the market.
There is a alternative rational answer.

Most of the answers assume that there is 1 correct price. And in linear equilibrium models this is true. But most time based models are non-linear which can have multiple correct answers. Note, non-linear models can handle emotional factors of fear and greed better than linear ones.

While a linear model might give a price of $100 a non-linear model might give you $95 to $105. In the non-linear model prices will hang around 1 price, then a some random time swing to the other price due to the fluttering of a butterfly’s wing.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
rockstar
Posts: 6326
Joined: Mon Feb 03, 2020 5:51 pm

Re: In general, why do stocks go up/down so much/drastically?

Post by rockstar »

Investors are irrational on a day to day basis. Over a decade equity prices make sense. Over shorter periods of time they’re erratic. This is why I index versus buy individual equities. It’s far less volatile.
User avatar
nisiprius
Advisory Board
Posts: 52219
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: In general, why do stocks go up/down so much/drastically?

Post by nisiprius »

I can push it off into a different question, which is why do people like to gamble? I don't know the answer to that, but the fact is that very many people do. For convenience I will say "we" do.

We like to do it in situations that we know are zero-sum games in which there is no return coming from anywhere, and the only way we can make money is by taking it away from someone else.

We like to do it in situations where there is a possibility of doing it by exploiting superior judgement or information (sports book, horse racing) and we like to do it in situations where there isn't (shooting craps, state lotteries).

Before 1922, people liked to gamble in bucket shops. These were establishments with stock tickers, in which no stocks were actually bought or sold at all, but people simply made bets on price movements--internal bets with other patrons, with the operator acting as bookmaker.

Gambling can be mediated by a market mechanism. Prices will fluctuate, sometimes spectacularly, even when there is virtually zero in actual value and participants more or less openly acknowledge it. This is likely the case for what are politely called "alt-coins." Published interviews with alt-coin speculators make it clear that they do not expect the "coin" to be adopted at all; they expect it to be gone quickly. They are just hoping to find one that "lasts longer than a day" and giving them a chance to cash out at the right time and take money away from other speculators who didn't.

It seems clear enough that the stock market is a combination of a gambling element and a legitimate investment element. (By "legitimate investment element" I mean a mechanism to raise capital for enterprises with the credible ability to use that capital to make money).

The "up/down so drastically" simply identifies the times and the stocks where the gambling element is relative larger. Total market index investing--or other very broadly diversified strategies, including factor investing--does not eliminate the gambling element, but minimizes it, probably nearly as much as possible.

The existence of a positive average real return from the total stock market--made possible because money comes into the stock market from business operations, earnings shared as dividends or buybacks, not just from people buying stocks--makes it a far more rational activity than pure gambling. However, it is entirely up to the stock market participant to decide, by their actions, how to strike their personal balance between investing and speculating.

Tangentially, the efficient market hypothesis does not hypothesisize that the wild price swings reflect correct value. It only claims that the wild price swings follow a random walk around the correct value, and that they cannot be exploited in any consistent way to beat the market average.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Post Reply