Record levels for the major stock indexes generate a lot of media attention, whether it is a record high or record low.
For the most part, these are meaningless numbers for the long-term investor. They signal a reaction by traders to some news/information that the traders believe will move the market in a certain direction.
If the traders are correct, they can profit from this change. However, most people who try to make a living trading on short-term price changes don't succeed.
For the long-term investor (defined at looking at least five years out), the daily fluctuation of stock or index prices means nothing.
The most widely reported piece of information about a stock is its price per share. The share price is updated many times during each day the stock market is open.
However, with some exceptions it is often not the most important piece of information you need to know about the stock and the company.
What does the per share price tell you about a stock? There are two ways to answer this question.
The first and most important thing you need to know is that for long-term investors, a stock's price is not the same as what the stock is worth.
For the long-term investor, a stock's worth is the potential for growth, dividends and so on. It answers the question: What would you pay today to benefit from the future earnings and associated growth in share price?
This brings us to the second answer to the question about what the price per share tells investors. During the regular buying and selling of the daily market, a stock's per share price tells you where buyers and sellers agree.
For example, if the price of a stock is $25 per share this tells you that there are buyers willing to pay $25 per share and sellers willing to sell for $25 per share. This is a simple explanation of a complicated process that can see this balance recalculated many times each minute the stock exchange is open.
For people who trade stocks, that is frequently buy and sell in an attempt to profit from price changes, there is little concern about long-term prospects for a stock. They are focused on the supply and demand balance and attempt to anticipate changes that may cause prices rise or fall.
When the stock market is especially volatile, investors can become very nervous. A sharp rise or drop in the stock market will often lift or lower prices for most stocks. This movement can be a reflection of the market's concern about current events or future economic conditions that may hinder or help business.
The classic mistake long-term investors make is to panic following a sharp drop in price and sell. Then, when the stock market rebounds, they buy back in. However, the odds are extremely high that the spooked investor will sell low and buy high - not a winning strategy.
There is a market saying that long-term investors should only care about the daily price of a stock on the day they buy and the day they sell. In between those two events, long-term investors should ignore daily stock prices.
The qualifier for this cliche is it applies only under certain conditions:
- If you don't need to sell (to pay for retirement expenses, for example) for five or more years.
- If the whole market is rising or falling, a stock's price will likely go along with the tide even if there is nothing that suggests any problem with the company.
- If your stock is experiencing sharp swings, but the stock market is not, you may want to re-look at the stock to see if anything has fundamentally changed with the company or its market.
- If you need to cash out of a stock as part of a financial plan (retirement, college expenses, and so on), you should pay attention to the daily price changes and plot your exit well in advance. This is why you need a five-year window, to give you the time to pick your exit rather than waiting until the last minute and taking whatever the market gives you for a price.
Long-term investors should not be frightened by daily price changes, but they should not be blind to changes in a stock's price that suggests the company has fundamentally changed and may not offer the future benefits you anticipated.