What Happens When Stocks Go on Sale?

What Makes Stock Prices Go Up and Down?

How do stocks go up and down? People trade for many reasons! Perhaps a large investor sold a lot of shares. Perhaps it's the day after an ex-dividend date and people have taken their payouts and want liquidity. Perhaps there's national or global uncertainty for the industry or sector. Perhaps automated stock trading run amok dropped stock prices. Perhaps it just happens every now and then.

These daily changes are only mildly interesting, unless you want to maximize the value of every trade you make. Avoid that trap; don't get greedy. Over the long term, stock prices rise as the value of the businesses they represent increase.

What Should You Do When Stock Prices Go Down?

Investors may have a thousand post-hoc justifications for why any day in the stock market turned out like it did. You can't make a rational story out of daily fluctuations.

Instead, spend your time looking for good stocks. A flash-in-the-pan stock with people excited because they think other people want to buy it is risky; you could end up holding the hot potato when the market stops. Good stocks hold their value over time.

A Stock on Sale is an Opportunity

Sometimes good stocks go on sale, and that brings opportunity. Remember: the price you pay for a stock governs how much money you can make. If you buy a stock on sale, you improve your chances of making the profit you want.

Maybe this feels contrarian ("especially in economic views", ha!); this is a test of your patience. If you've found a good company, can you wait until the price is right before you buy it? Can you wait, even if everyone else is buying and pushing the price higher and higher? Can you wait patiently for a sale?

Make a portfolio of great stocks you'd like to own. Then wait, patiently, for them to become great opportunities. Given the choice to buy stocks now or wait for a sale, do you know the price at which you'd like to own a good company? That's a question of discounted cash flow analysis and your margin of safety.

If you can find the right price and practice the discipline of investing only at safe prices—you will have become a wise (and successful) investor. Visit our stock analysis section to get started.

How to Tell a Sale from a Falling Knife

Not every price drop is a sale. Sometimes a stock falls because the market has correctly identified that the business is worth less than it used to be—a declining moat, a broken balance sheet, a permanent shift in the industry. Buying purely because a price has dropped, without checking whether the business itself is still sound, is how investors end up catching a "falling knife." Before treating a price drop as an opportunity, ask:

• Has anything about the business's earning power changed, or is this a market-wide move affecting many stocks?
• Is the drop tied to a specific, temporary event (a missed earnings estimate, a sector-wide selloff) or to a structural problem (a competitor displacing the business, a broken product line)?
• Would you be comfortable owning this company for the next five to ten years at this price, even if the price fell further first?

If you can't answer those questions with confidence, the "sale" may not be one.