Whether looking at individual stocks or a particular index, when sentiment turns negative this can lead to a drip feed that drags prices downwards. If we look at individual stocks, day traders and short-term traders specifically look for oversold positions. This allows them to take advantage of market volatility and hopefully buy at the bottom.
While buying any stock on the way down is akin to “catching a falling knife”, history shows you will often see one final huge sell-off before the recovery begins. Have you got the patience to wait until that moment?
Sentiment is everything
Traders will know that sentiment can change in the blink of an eye; darlings of the stock market today can become pariah tomorrow. Traders are ruthless, analysts can compound difficulties with their forecasts and the build-up of negative sentiment can be long and suffocating. As a short-term trader, every penny every cent matters and trading discipline is everything.
No stock and no index will fall in a straight line; there will be periods of hopefully buying which attracts that unfortunate phrase, a “dead cat bounce”. This is that moment when negative sentiment is suddenly reversed by hopeful buying prompting a short sharp bounce in the price. This bounce tends to be brief, with some traders registering a turn andprofits while others suddenly find themselves facing losses.
Testing the nerves of investors
As a previous darling of the stock market starts to disappoint, cracks appear and the future no longer looks rosy, this prompts an array of emotions amongst investors. Some investors will simply sell at the first sign of trouble, rightly or wrongly, while others will be ruled by their hearts rather than their heads.
“Surely this downturn is only short lived, a blip on an otherwise long-term enjoyable journey”
Shares which constantly deliver positive returns for investors tend to attract a premium valuation over their competitors. As they have previously outperformed the sector, delivered greater returns than their competitors, they are seen as more reliable. So what happens when the bubble bursts?
Lofty valuations mean there is often further to fall
Once the tide turns on a company, a premium valuation over competitors can disappear in an instant. Consequently, you could argue that previous growth companies which have attracted lofty valuations have further to fall. Generally, the erosion in the company’s valuation tends to be gradual after that initial fall on disappointing news. Further investigation may reveal other problems, uncertainty in the short-term and concerns for the longer term.
As the tide turns, support levels are broken and stop losses kick in, buyers move to the sidelines and sellers take control. Shorters can often exacerbate a difficult situation, increasing the downward pressure. Frustration amongst some investors that failed to bail out higher up can see them hold on for that “inevitable recovery”. As the share price continued to fall, their frustration builds until eventually, more bad news emerges, they crack. It’s time to sell, at any price, just get out!
It’s darkest before the dawn
Stock market share price movements are often compared to an elastic band. They can be stretched on the upside, stretched on the downside but eventually they snap back to something akin to fair value. That final sell-off, that moment when long-term confidence disappears, hope of a recovery is dashed, that is the darkest moment before the dawn. What are the main characteristics of this last huge sell-off?
This phenomenon is fairly common, the share price moves into freefall, huge volumes are traded and buyers are nowhere to be seen. Then quickly, in the blink of an icon of an eye, value investors and short-term traders take advantage. They have waited until sentiment is at its lowest, all recognisable stop-loss limits have been broken and the company does not appear to have a friend in the world. As the darkness begins to clear, the morning light of a new era emerges, a degree of balance and reason can take over.
Was the share price fall overdone? Did investors overreact? Is the company now a potential takeover target? How does the valuation compare to asset value?
The elastic band snaps back
Day traders and short-term traders are experts at spotting oversold positions and benefiting from that huge final flick of the tail, that last big sell-off. Time is of the essence which is why here at GIS UK Ltd we continue to invest in new technology, cutting edge dealing platforms and settlement services. This allows us to remain competitive on charges, a key element for any short-term trader.