What really drives stock prices down?

What really drives stock prices? The price of stocks, just like groceries, is driven by supply and demand of people “the market” buying and selling. What drives stock prices and the stock market really is no more complicated than that.

Unless you make it more complicated, then it is for you.

What drives stock prices? It is probably one of the most asked questions we get.  It’s also one of the best questions, so I’ll share my observation of it as succinct as I can.

Many investors seem to believe stock prices, and therefore, the stock market is driven by the news of the day because they see the headlines. The press tries to construct a story of the cause and effect. But, if we look at the news headlines on any day, we observe vastly conflicting narratives and reasons for a stock market directional move. 

To be sure, here are the headlines I found online today. According to headlines, recent price action and volatility are driven by everything from Trump’s talk on a China trade deal to an overvalued stock market to factory data to the fear of missing out.

what drives stock prices

The answer is, “all of the above” drives the stock market.

The news is newly received or noteworthy information, especially about recent or relevant events. However, none of us can say which specific news actually drives stock prices. 

If you really want to know what drives stock prices, it’s just the market, doing what it does.

All information and news have the potential to drive stock prices, as does investor sentiment. The price of stocks, just like groceries, is driven by supply and demand of people buying and selling. When emotion gets imbalanced, prices trend. Yes, there’s another asymmetry!

When supply and demand are symmetrical, the price stays the same.

When supply and demand are asymmetrical, the price trends in the direction of the most pressure and enthusiasm.

After yesterday’s close, I saw someone ask, “Why did the stock market do so bad today?”

I’m guessing he saw a headline like this:

what drives the stock market causes stocks to go up and down

However, a Dow decline of -0.96% isn’t a significant drop, but if you anchor to the “-268 point drop” as most do, it may sound worse, to you.

I focus on the % change to normalize the movement. Normalizing with the percent change adjusts the values measured on different scales to a notionally standard scale. For example, the “-268 point drop” is one thing from an absolute level of 27,783, but a very different situation when the Dow was at 10,000. At today’s level of 27,783, it’s only -0.96%, but the same point drop when the index was 10,000 is -2.68%, nearly three times the single-day loss.

A -1% single-day decline in the stock index isn’t a lot by historical standards. If it feels like it is, the investor should either better inform themselves of market history or have little to no exposure to the stock market. I’ll help with the former below.

First, here are the stats. I’ll continue to use the Dow Jones Industrial Average index data.

So far, in 2019, the Dow has declined -1% or more on 18 days. When it declined -1% or more in a single day, the average drop that day was -1.7%. So, a -1% drop isn’t uncommon. It’s well within a normal range for a down day. I count about 231 trading days so far in 2019, excluding holidays, so 18 of those days falling -1% or more is nearly 10% of the days. And remember, the average drop those days was -1.7%, yesterday was only -1%.

Oh, and the worst day so far in 2019 was -3%, so it could be three times worse!

When we extend the lookback period to this time last year, the Dow declined -1% or more on 26 days. When it declined -1% or more in a single day, the average drop that day was -1.87%. Again, a -1% drop isn’t uncommon. Last December was a very volatile month.

2018 was more volatile than 2019, so far. In 2018, the Dow declined more than -1% on 35 days, and when it did, the average drop was -2%, and the worst day was -4.6%.

Investors tend to anchor to the recent past and extrapolate it into the future. That is, humans tend to expect what is happening now to continue. After a volatile 2018, most investors probably expected a volatile 2019. For many, the down days and downtrends in 2018 were a shocker after an abnormally quiet 2017. In 2017, the stock market trended up with little downside. We only saw 4 down days of -1% or more, and the average down day was only 1.3%, and the worse was 1.7%. You can probably see how many were stunned last year.

This may make you wonder when investor fear drives down stock prices, what is a “normal” down day?

It depends on the time frame and the market state over that time frame. Over the past three years, the Dow declined 57 days more than -1%, and the average down day was -1.9%, and the worst was -4.6%. That’s nearly 700 data points, so the sample size is likely enough to say we should expect a -2% down day is going to happen, and a -5% is possible.

To expand the sample size, I wondered how many -1% or more down days I’ve dealt with since I started managing our primary portfolio in May 2005. In the last fourteen years, the Dow has dropped -1% or more 427 days, and an average decline was -1.8%, and the worst down day was -9.4%! You can probably see why a -1% down day from my perspective isn’t a big deal, and the statistics of the data also confirms it’s well within a typical down day.

Of course, the trouble is larger downtrends being with down days. So, the investor’s concern isn’t just a single down day, but instead a series of down days, which is a downtrend. Before moving on to what drives stock prices and the stock market, let’s look at the downtrends.

Over the past year, the Dow Jones has declined more than -5% twice and -20% once starting last December. All of these downtrends include -1% down days. So, I’m not saying they don’t matter, but instead, the single -1% down day isn’t by itself significant.

Expanding the lookback period to the past 10 years, we see many downtrends of -5% or more. But, within those downtrends, there was only one -5.4% down day, but 245 down days over -1% with an average loss of -1.6%. Downtrends include these down days.

Next, we look all the way back to the beginning of the index data to observe its historical downside. The 1926 era Great Depression was by far the worst when the Dow Jones Industrial Average fell over -75%. It makes the 2007-09 period when it fell -50% look tame.

Clearly, if you invest in the stock market, you should expect to experience drops of -5% a few times a year, and -10% maybe once a year, and -20% or more at least every market cycle. If all you do is buy and hold stocks or stock funds, expect to experience a -50% because if history is a guide, it has happened before, so it could happen again.

You can probably see Why we row, not sail.

To understand what drives stock prices and how much of a loss is considered a large loss, we have to know the history. I hope I’ve shared it in a helpful way.

If there’s anything I hope individual investors get from my observations, it’s a better understanding of the risks of investing. The rewards of investing are well advertised, but the risks are what matters the most when our focus is asymmetric risk/reward. When prices of positions are trending in our favor increasing our investment account value, our concern isn’t that we are making too much money. Our interest is not giving up all the profit, which is a risk management function.

The exit, not the entry, always determines the outcome.

If you want to know what really caused the decline, I shared my opinion in a single chart that I believe sums it up best. It was good enough to make it in The Daily Shot in the Wall Street Journal. As the stock index has trended up quietly in recent weeks, volatility had contracted, as seen in the chart. As I shared, “Periods of low volatility are often followed by volatility expansions.”

Mike Shell Wall Street Journal WSJ

A few weeks ago, I also observed investor sentiment had reached an extremely optimistic level as stated in Investor sentiment signals greed is driving stocks as the U.S. stock market reaches short term risk of a pullback.

Now that stock prices have fallen two days in a row, we’ll start to see the pendulum swing from extreme greed to a middle ground. If the stock market drops a lot more, investor sentiment will become fearful, just in time for a reversal back up again.

Some favor stories, others favor data and charts, I’m a math guy, so I prefer the data and visually seeing it in charts. I’m lucky to be able to write.

What we have here isn’t a failure to communicate, the news is everywhere. I think it’s a misunderstanding of what really drives stock prices down. It’s the desire and enthusiasm to sell.

Stock price trends, just like groceries, are driven by supply and demand of people buying and selling. When sentiment gets imbalanced, prices trend in the direction that has the most force and momentum.

Yes, it’s another asymmetry! Without the asymmetry, prices would stay the same.

In the spirit of ASYMMETRY® and asymmetric risk-reward payoffs, I’m naturally trying to get the most reward from my observations by helping as many people as possible, so share it! And enter your email on the right to get immediate notices of new ASYMMETRY® Observations. We do not sell or use your email address in any other way. Also, follow me on Twitter: @MikeWShell

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The use of this website is subject to its terms and conditions.

Charting and technical analysis of the stock market trend

I usually share more of my observations of the stock market trend when the shit hits the fan. The truth is, I enjoy volatility expansions more than the quiet, calm trends. There isn’t as much for me to talk about when the trends are calm and quiet.

I also try to point out, in advance, when I believe we may see a volaltity expansion like we are now. You shouldn’t expect it from me as I’m ultimately an investment manager, not a Mark Twain, so my own tactical trading decisions are my priority. Also, what I share here doesn’t necessarily represent what I am trading in our managed portfolios. In fact, I usually try to avoid mentioning any symbol, stock, ETF, etc. that I may be trading or invested in. As such, use my observations at your own risk as it is not investment advice. With that said…

Here is the one year chart of the S&P 500 with some basic technical analysis applied. The blue trend line I drew overhead is where we would have expected to see “resistance become support,” but it hasn’t. So, there wasn’t enough buying demand to overcome selling pressure today. Based purely on quantitative measures as I’ve shared over the past week, it isn’t a surprise to see a volatility expansion and price trends widen out.

stock market momentum and support resistence

I marked how the current decline relates to the past two. This one has turned down rather sharply and quickly as of today. The SPX stock index is down about -6% from it’s high of which nearly half of the loss is today.

I now expect we’ll see some buying interest step in… at least temporarily. Only time will tell if this becomes a waterfall decline like we saw October to December, or worse.

I haven’t mentioned any news items that could be used as catalysts. Last week it was the Fed and employment, today it’s China, Hong Kong, and Trump tweets. Contrary to what most people probably believe, the range of prices broadening out and price trends falling is something I thought we may see as a normal quantitative reaction. Whatever may get the blame, it’s just the market, doing what it does. I can assure you of only one thing: I’ve heard a wide variation of reasons today from different levels of people. On the financial news, it’s one thing, from global macro hedge fund managers, it’s another. For example, one mentioned the Chinese PLA army is building on the Hong Kong border…

“May you live in interesting times” 

Ironically, it is an English expression purported to be a translation of a traditional Chinese curse.

In the meantime, my short term momentum systems are showing the broad stock index reaching its lower range of probabilities, so we “should” see it retrace up at some point, at least temporarily. Of course, there is always a chance of a waterfall decline the moves much deeper than a normal range of probabilities. In fact, we have already seen that now if you look at the chart. The price trend has moved below the “normal range of the market” as measured by the lower band.

We’ll see how it all unfolds.

If you want to follow along, sign up on the right to get automatic emails immediately when I share a new observation. 


Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Logical Inconsistency?

One of the most widely quoted words of wisdom from legendary investor Warren Buffet is,

 

“Rule No. 1: Never lose money.

Rule No. 2: Don’t forget rule No.1.”

 

But.. is it a logical inconsistency?

Warren Buffet Rule number 1 lose money BRK $BRK Berkshire Hathaway

Logical Insonconsinecy:

When multiple statements are given which contradict one another.

These may be given together or may be separated in time. Sometimes the contradictions are rather subtle and are difficult to spot. At other times, they are obvious. If you have enough authority, then you may be able to carry this off.

 

For me, actively managing risk for drawdown control is essential to “not lose money.”

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

The Trend of the U.S. Stock Market and Sectors Year-to-Date

As of today, the below table illustrates the year-to-date gains and losses for the S&P 500® Index (SPY) and the 9 Sector SPDRs in the S&P 500®. We observe the current and historical performance to see how the U.S. Sectors match up against the S&P 500 Index.

So far, the S&P 500 Index is down -5.68% year-to-date. Only the Consumer Discretionary (XLY) and Health Care (XLV) are barely positive for the year. Energy (XLE) has entered into its own bear market. Materials (XLB) and Utilities (XLU) are in double-digit declines.

year to date S&P 500 and sector returns 2015-09-10_11-31-05

Source: http://www.sectorspdr.com/sectorspdr/tools/sector-tracker

The trouble with a table like the one above is it fails to show us the path the return streams took along the way. To see that. below we observe the actual price trends of each sector. Not necessarily to point out any individual trend, but we can clearly see Energy (XLE) has been a bear market. I also drew a red line marking the 0% year-to-date so point out that much of this year the sectors have oscillated above and below it and most are well below it now.

year to date stock market sector trends 2015-09-10_11-32-40

Source: http://www.sectorspdr.com/sectorspdr/tools/sector-tracker

Speaking of directional price trends is always in the past, never the future. There are no future trends, today. We can only observe past trends. In fact, a trend is today or some time in the past vs. some other time in the past. In this case, we are looking at today vs. the beginning of 2015. It’s an arbitrary time frame, but still interesting to stop and look to see what is going on.

As many global and U.S. markets have been declining, you can probably see why I think it’s important to manage, direct, limit, and control exposure to loss. Though, not everyone does it well as it isn’t a sure thing…

The Trend of the U.S. Stock Market

When I say “The Trend” that could mean an infinite number of “trends“. The general definition of “trend” is a general tendency or course of events.

But when I speak of “The Trend” I mean a direction that something is moving, developing, evolving, or changing. A trend, to me, is a directional drift, one way or another. When I speak of price trends, I mean the directional drift of a price trend that can be up, down, or sideways.

Many investors are probably wondering about the current trend of the U.S. stock market. So, I will share a quick observation since one of the most popular U.S. stock indexes seems to be right at a potential turning point.

Below is a 6 month price chart of the S&P 500 stock index. The S&P 500® is widely regarded as a gauge of large-cap U.S. equities. Clearly, prior to late August the stock index was drifting sideways. It was oscillating up and down in a range of 3% to 4% swings, but overall it wasn’t making material higher highs or lower lows. That is, until late August when it dropped about -12% below its prior high. Now, we see with today’s action the stock index is attempting reach or breach it’s very recent peak reached on August 27th. If the index moves above this level, we may consider it a short-term uptrend. We can already observe the index has made a higher low.

S&P 500 stock trend

Source: Shell Capital Management, LLC created with http://www.stockcharts.com

You can probably see how the next swing will determine the direction of the trend. If it breaks to the upside, it will be an uptrend as defined by “higher highs and higher lows”. Although, that is a very short-term trend, since it will happen within a more intermediate downtrend.

My point is to observe how trends drift and unfold over time, not to predict which way they will go, but instead to understand and define the direction of “the trend”. And, there are many different time frames we can consider.

If this trend keeps going up, supply and demand will determine for how long and how far. If it keeps drifting up, I would expect it may keep going up until some inertia changes it. Inertia is the resistance to change, including a resistance to change in direction.

But if it instead goes back down to a new low, I bet we’ll see some panic selling driving it even lower.

The real challenge of directional price trends is if this is the early stage of a larger downward trend (like a bear market), there will be many swings along the way. In the last bear market, there were 13 swings that ranged from 10% to 27% as this stock index took about 18 months to decline -56%.

Below is the same stock index charted with a percentage chart to better show the percent changes over the past 6 months. You can probably see how it gives a little different perspective.

S&P 500 stock index percent chart average length of bear markets

Source: Shell Capital Management, LLC created with http://www.stockcharts.com

I don’t necessarily make my tactical decisions based on any of this. I enjoy watching it all unfold and I necessarily need to define the trend and understand it as it all plays out. I want to know what the direction of the trend is based on my time frame, and know when that changes.

I believe world markets require active risk management and defining directional trends. For me, that means predefining my risk in advance in each position and across the portfolio.

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For informational and educational purposes only, not a recommendation to buy or sell and security, fund, or strategy. Past performance and does not guarantee future results. The S&P 500 index is an unmanaged index and cannot be invested into directly. Please visit this link for important disclosures, terms, and conditions.

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