In this post, I'm going to teach you why stock prices fluctuate... sometimes wildly. This post is specifically for those newer to active trading. So, as always, if you already know everything, you probably want to skip this post and move on.
Everyone else... Let's proceed.
The Source Of Stock Price Movement
The prices of stocks and other actively traded securities can vary wildly over the course of different time periods. This is what's known as volatility.
The formal definition of volatility via Wikipedia - In finance, volatility is the degree of variation of a trading price series over time, usually measured by the standard deviation of logarithmic returns. That's a fancy way of saying how much price varies around the average price over a given period of time. Below is a crude illustration...
As the image shows, it's possible to achieve the same average outcome even when the prices of the "trades" vary widely. In the example, the difference shown is between the trade and the average price and represents a rudimentary [non log] form of volatility. On an actual stock chart, the trade prices would vary around the trend lines in much the same way [albeit with much wider variance and a lot more price points]... but the result would be much the same... volatility could be [likely should be] embraced as a tool to help you achieve your desired ends... better entry points [see below]. In fact, the underlying concept here is the source of my most profitable trade setups. But I'm getting ahead of myself.
So while often derided with angst-filled concern as the reason to avoid active trading, volatility is actually the source of trading profits... even for so-called long-term holders.Allow me to explain.
There are a number of things that impact stock prices. In the short term [intraday to days] the leading source of movement is new information about a stock... rumors and/or news about the specific stock or, to a lesser degree, the stock's sector. More accurately, the perception of the rumor/news by active traders of the stock drives its movement.
This is an important distinction, so allow me to pause and dig a bit deeper.
A plethora of information about different stocks hits the news wires every day. Additionally, but no less important, even more rumors are whispered on trading floors and in chat rooms daily. Only certain bits of that information "will move stocks" to any degree worth mentioning. The reason? Only some of the bits of information drive traders to change their perceptions of a stock enough to take action [buy or sell the stock] to protect their interests and/or achieve their profit goals. And since the actual movement of a stock is dictated by supply and demand [the balance of stock wanted to buy vs available for sale at different prices], those traders' aggregate perceptions of the information and rumors swirling around each day literally dictate the movement of stocks as the information alters those collective perceptions.
So to be clear, what you see when you look at a stock chart is a graphical presentation of the market's shifting perceptions of the stock's prospects. The market is engaged real-time in what's called "price discovery." Buyers and sellers are constantly "voting" on the correct price for a given asset with their money.
Buyers think the correct price for the shares is higher... thus they are willing to buy at the current price.
Sellers think the correct price is, at a bare minimum, the price at which they're selling [and arguably lower], thus they are willing to part with their shares.
The constant flow of information shifts the perceptions of each to varying degrees such that they are more or less willing to transact.
One of the biggest impacts of information happens when that significant information comes out when the market is closed. If the information changes the collective perceptions of the value of the stock enough while the market is closed, price will gap [not trade at a number of prices between the price where it last traded and where it opens].
Incidentally, intraday gaps happen as well, but they are far less frequent as companies tend to release market moving information during off hours.
The process is much the same over longer periods of time... as in weeks to months. Fundamental information [sales, revenue, earnings, future prospects, etc.] finds its way into the prices of stocks via traders' perceptions just as rumors and headlines do over shorter periods. In fact, it might be argued that traders have been intimating that trouble was coming for ALLK for a long time given the trend...
Volatility As Opportunity
I mentioned earlier that volatility is actually the reason there's opportunity in the stock market. Here's what I mean by that... Notice that in the course of moving from above $100/share to around $85 per share before the dramatic collapse on December 22nd, price moved smoothly toward $70 before rallying [retracing] back above $80. That rally and the subsequent stall created an opportunity for those believing the downtrend was not yet done to enter shorts with barely any capital exposure [risk] and the opportunity for a substantial gain if price only fell back to [or below] $70.
That's the value and opportunity of volatility.
Since it's my opinion that most of the readers/followers of this blog should focus on long [purchase] plays, here's another example of volatility in action in the S&P500 etf, SPY.
As you can see since from May of 2021 through the end of the year, SPY moved approximately $30 higher. But the move was not without pauses and pullbacks. These are noted by the yellow ellipses I placed on the chart in the least scientific way possible. The point is, there was opportunity after opportunity to enter a low risk long position in the direction of the larger uptrend if you believed SPY's ultimate destination was higher... all because of the security's volatility.
The Bottom Line
Stocks do indeed fluctuate quite a bit because of changing perceptions of the underlying companies' prospects... and that volatility is a golden opportunity for the well educated and, just as important, the well prepared. While the "how" of taking advantage of those opportunities is beyond the scope of this post, hopefully, you can see a glimmer of the possibilities... and with that, the beginnings of a path to resolving your retirement crisis.
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You might also like:- The Simple In Simple Trading
- The Power of Compounding
- The Stock Market Auction Process
- How To Think About Your Trading Losses
- The Fast Track To Financial Independence
- The Importance of Simple Trading Rules
- How To Use Support & Resistance In Your Simple Trading
- How To Use A Stock Picking Service
- How To Trade F.A.A.N.G.M.
