Have you ever wondered why stocks don’t move in a straight line? Almost every stock seems to move in a zigzag manner, rising and falling multiple times within the same trading day. Sometimes, it doesn’t make any sense to new investors and traders who look at stock prices in awe, unable to understand the logic behind the weird behaviour.
There are lakhs of investors and traders who are buying and selling stocks every single second in a trading day in the stock market. It is extremely rare for every single trader and investor to agree on the rise or fall of a stock for more than a few minutes. Once the stock has risen a certain amount, the bears would jump in with a shorting opportunity driving the price down and vice versa. There is no stock on which every single person has the same opinion. This is the fundamental reason why stocks do not move in a straight line.
Here are some other reasons why stocks don’t move in a straight line.
1. Different investment horizons
Since there are lakhs of investors and traders trading every second in the stock market, there are lakhs of opinions & lakhs of investment horizons. Some people are extremely short term traders who are looking to book profits on the same day of the trade (called intraday traders). There are others who are swing traders who hold the stock for a few days/weeks in the hope of making a profit. And there are some long term investors who are in the game for the long run. There are different types of people in the long term investor category itself – some think that long term investment means a 1 year investment while others think that anything below 5 years isn’t a long term investment. Such a wide range in investment horizons ensures that the stock is unable to move in a clear straight line. As soon as the stock has moved a certain amount, there are short term traders looking to book profits sending the stock price back to where it started!
2. News
News plays an important role in the volatility of the stock market. A sudden bad news for a company or sector is enough to derail the short-term rally. Similarly, a sudden good news can send a choppy stock skyrocketing. This inflow of news happens continuously 24/7 which causes changes in the behaviour of the stock market investors and traders. This makes it impossible for stocks to move in a straight line!
Sometimes fake news or rumours are also spread about a company or sector to ensure that a select group of investors and traders enjoy big profits. This is why stock traders should never trade based on news, rather they should only trade based on chart. To learn more about this, visit the article – Should you trade based on news or chart?
3. F&O expiry
Futures and options (called F&O) are financial derivatives which derive their value from the assets which they represent. Simply put, they are financial contracts which expire at the end of the expiry day based on a specific condition. To learn more about options in the stock market, visit this article! The F&O contracts expire at the end of each week and the end of each month depending on the type of the contract. This expiry date (especially the weekly expiry) ensures that stocks will not move based on fundamentals in the short term. The short term movement takes place by keeping the expiry date in mind. This is sometimes referred to as Index management. To learn more about index management, visit this article!
Even if the company recently announced amazing quarterly results or made huge corporate announcements, the effect on the stock can sometimes be opposite because of the F&O expiry. This ensures that not everyone is on the same page regarding the movement of the stock price causing the zigzag movement of the stock.
4. Usage of margin
Usage of margin (debt) is one of the major causes of the stock market swings. The market knows that many traders and investors who are drowning in debt can be easily taken out in market swings. Unlike a long term investor who uses his/her own money in the stock market, margin traders (using very high leverage) are unable to hold their stocks for long if the market moves opposite to their anticipated direction. This phenomenon is called the margin call where a stock trader is forced to sell his/her holdings due to high leverage.
Suppose a long term investor has invested Rs. 10,000 in the stock market. There is a sudden fall of 10% in the market causing the value of the portfolio of the long term investors to go to Rs. 9,000. This is not a cause of concern for the long term investor because he/she knows that the stock market tends to go higher in the long run. So, all the investor has to do is to hold the stocks with unrealized losses (unrealized losses are losses in the books which do not convert to realized losses until the assets are sold). So, the investor who uses his/her own money is safe from margin calls.
Now imagine a stock trader who has taken 10 times leverage to build a portfolio of Rs. 1.1 Lakhs (own capital = Rs. 10,000 and debt = Rs. 1 Lakh). Such a trader will not be able to bear a 10% dip in the stock market. A 10% percent dip will send the value of his/her portfolio to Rs. 99,000 which is an unrealized loss of Rs. 11,000. However, since the trader has only Rs. 10,000 of his/her own capital and the rest is debt, this will force the stock broker to sell the holdings automatically due to lack of funds even before the 10% dip. This trader will lose his/her entire capital even though the stock market has taken a dip of only 10%. This trader just became a victim of the margin call!
But circuit stocks move in a straight line!
There are some stocks which somewhat move in a straight line undergoing constant upper and lower circuits. However, these stocks should be avoided by stock market investors and traders because these are often traps which are laid by big funds to make short term profits at the expense of retail investors. These stocks move in a straight line (continuous upper circuits) to trap novice investors and traders. The stock which moves up in a straight line, also comes down in a straight line. However, the final decision to invest or not depends entirely upon the reader!
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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