Alpesh Patel OBE looks at the causes and potential strategies when a stock that has risen significantly experiences a sudden drop.
When a stock that has risen significantly experiences a sudden drop, it can cause concern for many investors. This situation is common in the stock market, and it’s crucial to understand the reasons behind such a drop and the strategies to consider in response.
The causes can range from company-specific issues, such as lower-than-expected earnings or sales (as in the case of Apple), to broader market or economic factors.
Causes of Stock Price Drops
Company-Specific Factors: These include lower-than-expected earnings, poor sales, management changes, or negative news about the company. For instance, Apple’s stock price drop was due to decreased sales.
Market Factors: These include changes in market sentiment, economic indicators, geopolitical events, or sector rotation. For instance, if investors move away from tech stocks and into other sectors, Apple’s stock price could be impacted.
Economic Factors: These include changes in interest rates, inflation, or overall economic growth. For instance, if the Federal Reserve raises interest rates, it could make borrowing more expensive for companies, potentially impacting their profitability and stock price.
Strategies for Different Types of Investors
Long-Term Investors: For long-term investors, a drop in stock price could represent a buying opportunity, especially if the company’s fundamentals remain strong.
Value Investors: Value investors, like Benjamin Graham, look for stocks that are undervalued compared to their intrinsic value. If the drop in stock price is due to temporary factors and the company’s intrinsic value remains high, this could be a good buying opportunity.
Growth Investors: Growth investors, like Philip Fisher, look for companies with high growth potential. If the drop in stock price is due to a temporary slowdown in growth, but the long-term growth prospects remain strong, this could also be a good buying opportunity.
Income Investors: Income investors, who rely on dividends for a significant portion of their returns, should assess whether the drop in stock price will impact the company’s ability to pay dividends. I
Momentum Investors: Momentum investors, like Richard Driehaus, look for stocks with positive price momentum. A stock price drop could signal selling, especially if the price momentum turns negative.
A study by De Bondt and Thaler (1985) found that stocks that have performed poorly in the past tend to outperform in the future, a phenomenon known as “mean reversion.”
However, it’s also important to note that not all stock price drops represent buying opportunities. A study by Jegadeesh and Titman (1993) found that stocks with negative price momentum tend to continue underperforming, suggesting that momentum investors may be better off selling after a price drop.
Me? I am a value, growth, and income investor and momentum trader—the best of all worlds.
Alpesh Patel OBE
This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.