Buying On A Huge Drop
Sometimes, a stock will drop 25% or more in a day. Most often, this is the result of some bad news for the company. Perhaps the company is a biotech company and their wonderdrug proved to not be up to snuff, or perhaps some new legislation would cripple the company and possibly put them out of business. Whatever the reason, stocks will sometimes drop a lot in one day.
Some investors look to these drops as opportunities. When a stock drops, a lot of the stock’s investors simply panic and begin selling, pushing the price far too low. This recently happened with E-trade (ETFC). A report circulated about E-trade’s bad, almost toxic mortgage portfolio, and the possibility of bankruptcy surfaced. Due to the company’s small, though not totally insignificant chance of bankruptcy, many hypothesized that e-trade’s customers would move all of their assets out of the company, a sort of run on the bank. The stock dropped 59% in one day.
The next day, the stock shot up by 41%. Obviously, it didn’t recover all of its losses, but investors realized that people had way overreacted. There was almost no chance of E-trade going bankrupt, another company would simply swallow it up and take over its customer base. Those who had bought the company on the huge dip the day before were rewarded and those that sold proved to be huge losers.
When a stock drops a lot, it presents a buying opportunity. But, it may also just be a signal of more drops to come. You need to evaluate how detrimental the news is really for the company. The market will often overreact to news, but sometimes, a drop is warranted and buying the stock is just an attempt to catch a falling knife.
