One can never determine when a stock has reached its lowest point
In this article, David GONZALEZ (ESSEC Business School, Global BBA, 2023-2024) comments on the quote by Peter Lynch, “one can never determine when a stock has reached its lowest point”.
“one can never determine when a stock has reached its lowest point”. – Peter Lynch
Analysis of the quote
In the market, it’s common to witness some investors attempting to take advantage of the plummet of a financial asset, hoping to purchase it at a lower price, with the sole reference being its current price. As Peter Lynch wisely noted, “Trying to buy a plummeting asset is like trying to catch a falling knife. As a rule, it’s best to wait until the knife hits the ground, sticks, vibrates for a while, and only then attempt to catch it. Grabbing a rapidly falling stock leads to unpleasant surprises.”
About the author of the quote
Peter Lynch is one of the most renowned American investors who directed the Fidelity Magellan Fund from 1977 to 1990, under his leadership, it became one of the most successful mutual funds of all time. Currently, Peter Lynch serves as the Vice President of Fidelity Management & Research Company.
His book emphasizes an investment policy grounded in facts, implying that any small investor who recognizes a company’s success even before it becomes popular in the market can profit by purchasing shares before the flood of Wall Street buyers arrives. He also underscores that following “market experts” is a recipe for financial ruin.
Financial concepts related to the quote
I explain below three financial concepts related to this quote: volatility, price, and uncertainty.
Volatility
In precise terms, volatility in the financial market pertains to the speed at which an asset’s price can fluctuate. For instance, “one of the most volatile assets currently present in the market is cryptocurrency. In 2018, the monetary value of a single Bitcoin plummeted from slightly below $20,000 to less than $3,500” (Bodie, Kane, Marcus; 2021). Consequently, it is imperative to comprehend that when the price of an asset experiences rapid changes, it is typically attributable to a volatile market atmosphere. An effective gauge for assessing volatility is the VIX or Volatility Index. Once this index surpasses a threshold of 20, it indicates the presence of a volatile market climate. It is incumbent upon investors to remain cognizant of market volatility prior to taking positions.
Price Signifies Nothing
It must be understood that the price of an asset will never be a reliable indicator to determine whether an asset is oversold or not. To illustrate this point, let’s consider the case of oil prices, which on April 20, 2020, reached $0 USD. Clearly, many investors who sought to buy futures on this asset “at a bargain” ended up losing a significant amount of money. It is essential, therefore, for investors to look at other indicators before taking positions. Some of these indicators may include the previously mentioned VIX, keeping an eye on economic news such as the Federal Open Market Committee (FOMC), where the Fed communicates its decisions regarding interest rates, or even waiting for specific company results. Each trader must analyze the fundamentals of an asset to determine whether it is undervalued or not, as determining this solely based on price is misleading.
Uncertainty
One of the most common reasons for financial market downturns is uncertainty. During crises such as the COVID-19 pandemic or the subprime crisis, all investors seek to withdraw their money from the market simply because it is unclear what the future holds. The question for the trader is: if other investors are withdrawing their funds because they do not know what the near future holds for that asset, why invest there? It is better to have certainty that, based on results or improved expectations, the asset can be purchased at a lower price.
My opinion about this quote
Indeed, it is one of the key principles all traders should keep in mind when managing their finances. I believe that the most important aspect of investing is not just making money, it is avoiding losses due to lack of knowledge. I am among the investors who believe that as you gather more information, the risk of investing decreases. Therefore, determining that an asset is oversold with the sole source of information being its price is one of the biggest risks one can take in this business. I encourage traders to analyze this quote, as to succeed in the stock market, the most important thing is to avoid making impulsive decisions. Each investment decision should be executed following a consistent strategy or research.
Why should I be interested in this post?
Are you interested in starting to invest in the financial market? Do you want to learn how volatility and uncertainty affect asset prices? Would you like to take advantage of price drops in assets but are unsure when to buy? If your answer to these questions is affirmative, I invite you to read this post, as it will discuss all the topics related to these ideas. It will provide you with a more realistic view of what happens in the market, allowing you to resist the temptation of impulsive investing.
Related posts on the SimTrade blog
▶ Lou PERRONE Beyond Comfort: Navigating the Balance Between Risk and Reward in Finance
▶ Jianen HUANG It’s not whether you’re right or wrong
▶ Clara PINTO Investment is a flighty bird which needs to be controlled
Useful resources
Hull J.C. (2021) Options, Futures, and Other Derivatives Pearson, 11th Edition.
Lynch, P. (2015) One Up On Wall Street. Editorial: Titivillus.
About the author
The article was written in December 2023 by David GONZALEZ (ESSEC Business School, Grande Ecole Program – Global BBA, 2023-2024).