Assume you want to buy a stock you’ve been examining for some time. And finally, they announce a surprise bit of good news and the price rallies sharply higher and so you jump in.
Let’s say, you have a sudden profit on your hands but, the stock reverses. It has retracted back to your entry price. Actually, it has gone beyond your entry price and you are a loser! You may think that it’s just market games and “shaking out weak hands”. So, you decided to hold on, knowing that patience is a trading power. Finally, you’re down further than you expected to be in the stock.
If you were ultra convinced of the upside potential, you may see this as an opportunity to buy more shares at a better price. On the other hand, you may panic and sell as you continue to watch the price trend further against you.
Experts developed the “Efficient Market Hypothesis” which states that stock prices instantly diminish all news. So, there’s no possible way for a trader to profit from news releases. That experts feel that strongly.
We have some examples.
A few years ago, Samsung declared it is expecting record profits. And almost three times more than the same quartal the year before.
After the news, their share price fell.
That might seem without logic at first glance. But there are extra circumstances at this play. Almost at the same time, Samsung’s CEO resigned. He told that “the company was going through an unprecedented crisis” and that “a new spirit and young leadership was needed to respond to the challenges.”
What the CEO said to investors? I am upset, you have to be too.
And the first good news was forgotten. The upset in the management, which is bad news came to the first plan and share price dropped.
Let’s see when good news is bad news for stocks.
Often, when a company publishes earnings announcements, the market will respond by modifying the company’s stock price. If a company announces earnings release that doesn’t fit investors’ beliefs, the stock price is going to drop. The beliefs or expectations are the keys here.
Market expectations are part of the market price. As an example, a company has projected earnings per share of $1. They have always hit an earnings target. But investors may believe that announced price is undervalued and the company will really earn $1.10 per share.
And the company then publishes an earnings report of $1.05 per share.
Wonderful news, indeed! They defeated their own estimation.
Oh, no. There is the point where the good news becomes bad.
The investors believed the company must earn more than this $1.05 per share, do you remember that?
The stock’s price was charged at $1.10.
And what happened?
The stock price drops because investors sell off their shares.
This impact also can be increased by investors who just copy what everyone else is doing.
But there are some circumstances where obviously bad news for a company may be good for their stocks. For example, a company fired a large number of employees. That’s bad news for these people, indeed. At the same time, it may be good news for the company’s stock price. How? The company’s obligations are reduced. And the earnings can increase immediately.
A similar miracle can happen when a company has to make huge payouts.
For instance, the company announced a loss of $1bn. That is bad news, of course. Well, what if I tell you that this enormous loss came from one-off costs? And the bank wants to help on improving returns?
So, what is the conclusion? The stock price of that company will grow because the investors view the future potential.
To complicate things more, imagine the facts shows the economy is improving. That should be good news.
Oh, no! The investors may assume that such good news may cause a hike in interest rates.
So, we can freely conclude, good news for the economy can be bad news for the stock markets.
How should you react in such scenarios?
If the stock is basically strong, hold the stock despite the stock price going down. It won’t matter much in the long term if the company. Most of the great companies focus on their long-term goals. This means that a few times, they might miss the short-term expectations.
But, short-term interests shouldn’t be ignored completely by the company or investors. Nevertheless, if the company is overall performing good in the long run, then there’s no point of worry. In any business, there will be few difficulties in the short run.
Additionally, do not get connected to short-term expectations. Analysts will keep on making expectations every quarter. It’s their job and this is what they are paid for. If a company keeps on working for the short-term goals, it might never be able to focus on long-term growth.
Overall, if the temporary setbacks are not going to affect the long-term profitability of the company, then ignore the short-term fluctuations and hold your stock.
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When the company announced the good news and the price rallies sharply higher but the stock dropped suddenly. What are you going to do?
“Efficient Market Hypothesis” states:
Good news for the economy can be bad news for the stock markets.