Placing too much importance on the price of a stock and the history of price movements is a common mistake. A stock trading at 5 cents may appear cheaper than a stock trading at $50 but lower prices do not necessarily equate to greater value. If the 5 cent stock is actually overvalued and is really only worth 3 cents, whilst the true worth of the $50 stock is closer to $70, it is clear that the $50 stock offers better value. Investors may look at the 5 cent stock and reason that the price cannot go much lower. It can. Like all stocks, where the underlying business is flawed it has the potential to go to zero, taking your entire investment with it.
Stocks that have dropped sharply and then tracked sideways for a period can fool market watchers into believing the stock has “bottomed out” and cannot fall much further. This is not always the case. Much depends on the reasons behind the initial price fall and the impact of any remediation taken by the business to address underlying issues. Caution may be advisable is such scenarios – put the stock on your watchlist and wait for fundamental improvements in the business rather than rushing in based on movements in price alone.
The price range that a stock has traded in in the past will have little bearing on what it may do in the future. A stock grants the holder the right to future cash flows, thus the price should be the present value of those future cash flows. The stock prices will therefore reflect market players’ appraisals of the value of the flows at the present time. Companies and economies can change rapidly, however, and stock prices will logically move to take account of changed circumstances. Prices move based on new information and developments, not what the stock price did over the past year.
Day traders employ metrics such as the 52 week price range, which shows where a stock is priced in relation to its highest and lowest points over the past year, however this is not significant to the long term investor. Taking the time to develop a strong understanding of company fundamentals, future earnings prospects, and industry outlook will stand you in far better stead as a long-term investor.