this post was submitted on 28 Jan 2025
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Question: Stock rises as a result of its perceived value correct? So if a stock drops below its actual value, and many traders, having the knowledge that it's better to buy the dip when a stock drops below actual value or their peers, buy the dip, isn't it guaranteed that the stock rises?
I don't know how the stock market works, so this might be a dumb question.
It’s a good question, but stocks are a lot less logical than you may think. Bubble stocks, especially, are very emotion driven, very much FOMO.
For “boring” stocks, there are statistical models using all sort of financial data about the company, including things like assets, sales trends, new product predictions. Those stock’s prices will appear logical and relatively stable/predictable, but will make significant jumps either way as news comes out that may affect it. Investors buy or sell based on what they predict will happen, and make money if they get it right.
But for “exciting” stocks, this model doesn’t work as well anymore. The stock price is driven more by what people expect it will be in the future. Take Tesla stock as a great example. The price is sky high compared to the value of the company or its sales, very much unlike other car manufacturers what do you do when it’s still a minor company in vehicles sold, but the total stock value is far higher than any other? The CEO has made made some extremely ambitious predictions, that may justify the stock price, but are those predictions really going to happen? You may have heard in the news about investors “shorting” Tesla stock, usually represented as people who don’t believe in the future. The thing is, these were usually investors looking at the actual value of the company, the actual sales, even actual predictions of sales and deciding this does not justify that kind of stock price. They’ve usually been wrong and lost money, because the stock is not fact-driven, but emotion-driven. Now that CEO has come out with some extremely controversial views and is distracted from actually running his businesses, so that also affects the emotion around buying that stock. Will it still achieve the wild predictions? Do you have personally reasons to not invest in that person?
What is your perceived value of a stock? What is your prediction of how it will change in the future, based on how well the company is run, what their products, sales, and support are like, how their industry may change, and news that may affect them? For an established, stable stock, you can predict enough to reliably make money, but changes will be small so you won’t make a lot. For a new stock driven by hype, with the potential to revolutionize an industry, predictions are more like a gamble, more based on emotion than fact. However stock price changes in both directions will be big, so investors can make or lose a lot of money very fast, depending on timing.
Makes sense. Thanks for the explanation