Why Stocks Go Up And Down

There’s a popular story on stocks which very well explains the behavior of the short term stock markets. And at a time when markets are showing high volatility(as they often do), I thought you’d find this story interesting too.

So here goes.

It was autumn, and members of a Native American tribe ask their New Chief if the winter was going to be cold or mild. Since he was a Chief in our modern day society, he couldn’t tell what the weather was going to be like. Nevertheless, to be on the safe side, he replies to his tribe that the winter was indeed going to be cold and that the members of the village should collect wood to be prepared.

But also being a practical leader, after several days he gets an idea. He goes to the phone booth, calls the National Weather Service and asks,

Is the coming winter going to be cold?

The weather man responds,

It looks like this winter is going to be quite cold indeed.

So the Chief goes back to his people and tells them to collect even more wood. A week later, he calls the National Weather Service again.

Is it going to be a very cold winter?

The man at National Weather Service again replies,

Yes. It’s definitely going to be a very cold winter.

The Chief again goes back to his people and orders them to collect every scrap of wood that they could find. Two weeks later, he calls the National Weather Service again.

Are you absolutely sure that the winter is going to be very cold?

The weatherman replies,

Absolutely. It’s going to be one of the coldest winters ever.

To which the Chief finally asks,

How can you be so sure?

And the weatherman replies,

Well, the tribes are collecting wood like crazy.

This is pretty much how the stock markets work.

A critical point new equity investors need to understand is that when you buy the stock of a company, you are becoming a part owner of the business. You haven’t just bought a piece of paper which is supposed to just go up in value overtime. But what you’ve bought is a piece of all the company owns and represents. It’s brands, its hard working people’s aspirations, its infrastructure… And good businesses take time to grow and increase their profits.

On a day to day basis, despite the company’s stock price going up and down, nothing fundamental about the business changes. Factories still run as they would, people work as hard as they were in the days before. As awareness towards equity investing grows, you can only expect even more disconnect between a company’s stock price and its fundamentals.

So a stock price, and hence the market in itself acts like a crazy, neurotic child. But as long you own stocks of companies which are fundamentally good to begin with, you should just stop listening to all the noise and get some peace.

In a way, these market corrections are often necessary to give new investors a much needed wake up call. Several who do understand equities as an asset class, tend to panic and liquidate their mutual funds or discontinue their SIPs. While it is clearly a bad idea to do that for SIPs, study after study has even shown that liquidating your investments too, is one of worst things an investor could do.

Life is unpredictable and could be short. There is very little value in living it under duress; especially the kind of duress which news channels bring on the volatile stock market. They need news to put out. So you should gather enough wisdom to know when to ignore it.

Happy Moneyplanting.