Decisions on the stock market under the influence of the moment and of facts

At the start the stock market is often associated with buying and selling shares. You see prices, charts and daily changes in quotations, so it is easy to get the impression that this is precisely what all of investing consists in. After going deeper into this topic, however, something else appears. A change in the share price can arouse excitement, unease or haste. On top of this come other people's comments, opinions published on the internet and information about companies' results, problems in a firm or changes on the market. In such a situation what happens just before the investment decision matters a great deal. Some people want to buy or sell shares right away, because the price has just changed strongly or someone wrote that this is an important signal. Other people stop for a moment and try to check what exactly happened in the company. It is precisely here that the difference between reaction and analysis appears.

A reaction is a quick response to a stimulus.

Analysis consists in checking the facts and assessing whether a change in the share price results from the real situation of the firm.

This matters especially when you want to invest long-term. In such an approach what counts is the ability to assess whether a rise or fall in the share price is connected with the company's results, its debt, sales or prospects for further operation. This is exactly why it is worth understanding well when a decision is born under the influence of the moment, and when it results from stopping and checking information. It is from this that a more mature approach to investing begins.

The moment when emotion gets ahead of the assessment of the situation

A reaction on the stock market appears when a decision starts to result from the first impulse, and not from checking information. It may appear after a sudden fall in the share price, after a strong rise, after reading a short piece of information about a company's problems or after someone's firm opinion that you have to buy or sell shares immediately. At such a moment attention focuses on the change in the share price or on the information read, and not on checking what is really happening in the company.

This is well seen in a simple example. You buy shares of the first company you chose for your brokerage account. After a few days you see that the price of these shares has fallen by 8%. For a beginner Elegant Investor such a change may look threatening, because it is not yet known whether it is an ordinary swing in quotations or a signal of a bigger problem. The thought of selling quickly appears in your head, because the fall starts to be perceived as proof that the choice was bad. This is exactly what a reaction looks like. First the emotion appears, and only later the attempt to understand the situation.

In such moments it is very easy to simplify your assessment. A rise in price may be perceived as a sign that the company is good. A fall in price may be treated as proof that something bad is happening with the firm. A short piece of information about weaker results may be considered a signal for immediate action. Meanwhile, the change in the share price itself is not enough to assess the firm. The price shows how much investors are ready to pay for the shares at a given moment. It does not yet show by itself whether the company is developing sales, whether it keeps profit, whether it has high debt and whether its situation has really worsened.

What a calmer look at a company's situation looks like

Analysis on the stock market consists in checking what a change in the share price results from and whether it is connected with the company's situation. The price alone shows only the level at which shares are bought and sold at a given moment. It does not yet show whether the firm is increasing sales, achieving profit, has a safe level of debt or whether its activity is developing in line with earlier expectations.

In practice analysis means reaching for information about the company itself. It is worth checking whether the firm is improving its results, whether its costs are not rising too much, whether it keeps profit and whether something has appeared that may matter for its further operation. It is also worth establishing whether a given piece of information concerns only this one company, or covers other firms from the same industry too. Such a way of checking helps assess whether the change in the share price results from the real situation of the firm. A financial report is one of the documents that helps assess a company's situation. In it the firm shows, among other things, sales, costs, profit and debt. If, after the publication of such a report, the share price falls, the change in quotations itself is not yet enough to assess the situation. Analysis then consists in checking what exactly the company showed in this document and whether this information shows that its situation has worsened, improved or stayed stable.

A share price and a company's value are not the same

One of the most important discoveries for a beginner Elegant Investor is understanding that a share price and a company's value do not mean the same thing.

The price is the amount at which shares are bought and sold on the stock market at a given moment. It can change very quickly, sometimes under the influence of investors' emotions, and sometimes under the influence of new information about the firm.

A company's value relates to what its business looks like, whether it earns, how it copes with costs, whether it has a sensible level of debt and whether it has a chance to develop also in the following years.

This distinction helps tell a reaction apart from analysis. A reaction very often focuses only on the price. It sees the red colour on the stock market and reads it as proof that something bad is happening with the firm. Analysis reminds you that a fall in price may be a signal to look at the situation, but it is not yet a ready conclusion. First you have to check whether something lasting stands behind this change, or only a momentary mood of the market. In long-term investing this matters enormously. If someone buys shares with months and years in mind, they need to look more broadly than at a single day of quotations. Otherwise it is easy to fall into the habit of constantly reacting to every move of the market, and this leads to chaos, fatigue and decisions that are later hard to defend logically.

The first emotions connected with investing

At the start of investing many things appear at once. You have to get to know the basic concepts, understand how a brokerage account works, learn to read the most important information about a company and get used to the fact that share prices change every day. For a beginner Elegant Investor the mere observation of these changes can be burdensome, because every new situation seems important and requires assessment. Emotions then have a big influence on how the market is perceived. A rise in the value of the shares held can give a feeling that the decision was good. A fall can arouse worry that a mistake was made. On top of this come other people's comments, short opinions published on the internet and comparing your own decisions with what others do. In such a situation it is easy to focus attention mainly on the share price, because it is the most visible.

With time a beginner Elegant Investor begins to notice that observing the price alone is not enough to assess the situation. Her own approach to checking information about the company and greater attentiveness before making a decision become needed. Looking at what the firm does, what its results look like and whether the new information really matters for its activity helps with this. Such a way of thinking gives a better basis for a decision than reacting to every rise or fall in the value of the shares held.

Examples of reaction and analysis

Imagine two people who hold shares of the same company and see the same announcement. The firm informed of weaker sales in the last quarter. The first person immediately decides that something bad is happening with the firm, and sells the shares. The second person reads on. She checks whether the fall in sales concerns one market, one product or the whole activity. She checks whether the firm gave the reasons, whether the problem may be temporary and what the earlier quarters looked like.

The first person reacted. The second started to analyse. Analysis does not give certainty that every decision will turn out accurate. It does, however, let you base a decision on facts concerning the company. In investing this matters a great deal, because it helps you better understand your own decisions and draw conclusions for the future. This example also shows that analysis does not have to be hard for a beginner Elegant Investor. Sometimes it is enough to check whether the firm's problem appeared only once or persists longer, whether the company still achieves profit, whether it has a high level of debt and whether its activity is understandable to you. Such a way of checking information helps move from a reflex to a more conscious assessment of the situation.

How to move from reaction to analysis in practice

Leaving yourself a moment between new information and a decision matters a great deal. When the share price changes strongly or news about a company appears, it is easy to feel the need for immediate action. In many situations a few hours or one day is enough to better understand what happened. Such a short interval lets you first check the information, and only later assess whether the situation really requires a reaction.

Writing down the reasons for buying a given company's shares also helps. Such a note can contain the most important information on which the decision was based. You can write down what the firm does, whether its activity is understandable, whether it is increasing sales, whether it achieves profit and whether the level of debt does not raise worries. When the share price later falls or rises, it is easier to return to these notes and check whether something important has changed in the company itself.

A short moment of pausing before buying or selling shares also helps. When a strong urge to act appears, it is worth first establishing what exactly caused it. Sometimes the reason is important information about the firm. Sometimes the mere sight of a clear rise or fall in price. Such a check helps you better tell a decision based on information apart from a decision that results mainly from tension.

Long-term investing values the quality of thinking

A beginner Elegant Investor may get the impression that good investing consists in quickly responding to every change in the share price and constantly observing the market. Such an image often appears when the stock market is associated mainly with daily rises, falls and decisions about buying or selling. In long-term investing, however, something else matters more. It becomes important to understand what the company does, what its financial situation looks like and whether the reason for buying the shares still stays current after time passes. This does not mean that after buying shares nothing should be checked any more or that every decision has to stay unchanged. The point is that selling shares, buying more or giving up further investing in a given company should result from checking information about the firm. Such a decision can make sense when the company clearly worsens its results, loses the ability to achieve profit, increases debt to a dangerous level or stops meeting the conditions that justified the purchase earlier.

With time it becomes more and more clearly visible that on the stock market what matters is not only the knowledge of basic concepts, but also the way of thinking in moments of uncertainty. You can know what shares, an ETF and dividends are, and still make decisions too quickly if tension caused by a change in price takes first place. This is exactly why the difference between reaction and analysis has practical significance. It helps not only to better understand the market, but also to make decisions based on facts concerning the company.

What is worth remembering

On the stock market a change in the share price itself does not yet say whether a company has become better or worse. Only checking information about the firm lets you assess whether something important for its further operation is happening. This is exactly why pausing before a decision and separating the first impulse from checking the facts matters so much.

In practice this means the need to look more attentively at the reason for the rise or fall in price, at the company's results and at whether the new information really changes the assessment of its situation. Such a way of thinking helps limit hasty decisions and better understand your own behaviour on the market. It is one of those skills that strengthen the learning of long-term investing from the start.

Sources:

Investopedia (definitions of price, value and behavioural finance, https://www.investopedia.com), Morningstar (analysis of companies and markets, https://www.morningstar.com), CFA Institute (investor education on analysis and decision making, https://www.cfainstitute.org), Fidelity (educational resources for investors, https://www.fidelity.com), Bank of England (data and analysis on the economy, https://www.bankofengland.co.uk), OECD (data and analysis on economic conditions, https://www.oecd.org), Harvard Business Review (articles on decision making and psychology, https://hbr.org)

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