This is one of the most important things I could ever teach you about stock market prices…
How are stock prices determined? What causes stocks to go on sale?
The reason this is so important is because there’s a huge number of people who invest in the stock market, mostly your pension fund managers, mutual fund managers, and insurance fund managers, who have been taught in business school that stocks never go on sale.
They are taught that the value of the business is always the price of the stock.
I’m going to tell you why this isn’t true…
Stock Market Prices Don’t Always Equal the Value of a Business
Rule #1 investors don’t think that’s true. Warren Buffett doesn’t think it’s true, and the rest of the best investors in the world don’t think it’s true.
We in fact think that the market can get very emotional and sometimes, Mr. Market puts things on sale that shouldn’t go on sale.
What Causes Stock Market Prices to Rise and Fall?
Now, why would that ever happen? The guys that control the stock market are managing all the little guys money. They control about 85% of the money in the market. They’re very rational guys. They were the valedictorians of their high schools. They were the number one graduates out of Harvard. They went to Columbia Business School and they graduated number one there. They got into Goldman Sachs training program and they were the number one guy there. They got their own fund at age 30 years old. They are incredibly smart guys, smarter than we will ever be.
Why in the world would they ever put something on sale?
Why would they sell it to us at the wrong price?
We talk about going out to buy ten dollars of value for 5 dollars, that’s your basic Rule #1 strategy.
Who would ever sell you a ten dollar bill for five bucks?
Why would that ever happen?
The reason is because when these guys have a fund, their investment strategy for almost all of them, I would say 99% of them, is just to be sure that they are following the market.
The Big Guys are Momentum Investors
In other words, they are what is known as momentum investors. A long-term hold for most of these investors is 3 months, not 5 years. They’re in it for short-term gains on momentum. The stock is moving up, they join the trade, they try to get out at the top and then they move to another stock that’s going to move on. That’s how almost all of these guys invest.
If that’s how they’re investing and the length of time they’re going to be in a stock is 3 months, what do you think they are going to do if something happens to a company that’s going to make it a bad investment for a year?
How Stock Market Events Cause Stocks to go on Sale
Let’s say that cotton prices start to go nuts because of the Arab Spring. Maybe they’re not going to harvest Egyptian cotton crops, so cotton prices go from .85 cents to $2 dollars. The guys who own companies that depend on cotton prices to be low, let’s say a t-shirt company, the investors look at the price and say, “Oh my gosh, it’s going to take over a year before cotton prices come down, I need to get out of this company.”
This happens even if there isn’t anything wrong with the company, it’s just going to have a bad year, but they bail out on it. That company could go from 45 dollars to 15 dollars simply because there are no big buyers. They all get out of the company on momentum. This is what causes stock market prices to change.
How Rule #1 Investors Take Advantage of Stock Market Events
Well, we’re a really small investor. We don’t have to worry about our investors being momentum related. We can buy for the long term. We can wait, and when we see something that’s on sale because the big guys have sold it off, it takes us just a few seconds to get in there and take advantage of these stock market events.
This particular stock that you can take a look at for yourself is Gildan. In 2011 the cotton prices went to the moon and Gildan went on sale. We got to come in and buy at $16 bucks a share and Gildan went back to $50 dollars a share in just the next year or two.
This is how we take advantage of the fact that the big guys are momentum traders and we’re long term investors following Rule #1.
Take advantage when stocks go on sale. As Rule #1 investors, this is what we do best. If you want learn more about what you need to retire as a millionaire and get the most out of the stock market, click below to sign up for my FREE investing webinar.
Now go play.
P.S. If you’re serious about investing in the stock market, review these posts first:
Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.