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Stocks Fall on Positive News

by Peter Leeds

Read all the past Blog entries here

It sounds counter-intuitive, but bear with me for a minute here... because this is what causes your investments to lose (when they shouldn't). 

Picture this - what if you are absolutely right about:  
  • the company's upcoming financial results
  • your expectations for the business
  • the company's outlook
...but the shares dive lower!?!  
iphone microphonelipstick pigsirixm
Why is this?  The stock moves against every inch of logic and understanding you have.

Right now, you get to learn this life-changing wisdom through one example.  Let's picture Satellite Radio, but believe me that there are thousands of other case studies:
(By the way, see where we picked SIRI as a Hot List penny stock selection).
---  Get more great penny stock picks like SIRI just before it popped ---
You expect Sirius satellite radio to save costs by merging with XM.  Merge they did, and as a result they massively reduced expenses.  And the shares immediately... sank towards zero!  Not what you were expecting, I'd bet.

This was a perfect example of "Buy the Rumor, Sell the Fact."  (See page 14 of this e-book).  It was also a tipping point, where SIRI and XM went from "speculative potential" to being properly valued based on operational results.  No one cared the company was absolutely bleeding cash as long as they saw the light at the end of the tunnel.  That light was the potential benefits the merger would induce, and upon that event everything would be good forever, and the shares would trade dramatically higher... (at least that's what investors thought).

Upon realization of that magic moment, investors were now forced to look at the company independent of all the "one day if we could just" illusions, and actually notice the crippling debt.  As mentioned earlier, the shares went from being valued based on "speculative potential"  to reflecting their true value as a business.

This effect is magnified in more widely-followed penny stocks.  When one hundred million people think the shares will multiply in value upon the big, upcoming FDA approval, they've already bought due to anticipation.  The day that company actually gets the FDA's nod will be a very sad day for investors.  Great news comes out, but the shares aren't going up.  Instead, they are doing the other thing - falling.  They slide lower to make up for the sudden drop off in demand, mixed with the flow of investors moving out of the penny stock because it is no longer an FDA play.

Said more simply, as long as there is a greed-inducing distraction, traders don't notice the woman of their dreams is actually a pig in lipstick.  In the case of SIRI and XM specifically, it wasn't even high quality lipstick.  It was like "Forever 21" or "Revlon" or something.

Also, investors act on their expectations.  They inflate a stock's price (or pull it lower) based on their beliefs.  When that company releases awesome results, but which fall short of what was anticipated, the shares actually fall to make up for the overly-optimistic traders.  Even if the numbers were very good, but fell short of the anticipated results, the shares will be coming down.  The reality fell short of expectations.  The share price adjusts lower.

We'll keep it simple and to the point.  Investors were expecting even greater results, and bid the shares up to be reflective of that anticipation.  People knew such-and-such company was going to announce stellar results.  If those results, no matter how strong, do not blow away expectations, it will be a negative for the share price.

Investing is only partially about getting involved in a great company.  The real successes come when you buy shares of that same great company, but before anyone else, and there are either no expectations, or very easily-beaten ones.  Then as the expectations are exceeded, the shares adjust higher to appropriately reflect the improving results.

Tip:  Buy the Rumor, Sell the Fact
Investors often act on their beliefs, so if a rumor of a positive event is being spread, the underlying shares tend to go higher.  Typically, when the rumor plays out (ie- the fact is realized, or the important event takes place), the shares fall.  The shares of a company working on getting FDA clearance will often perform great, until they actually receive the clearance!

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