Why do some people want their stocks to decrease in value? What advantages are there to having stocks go down instead of up?

 

   While the conventional wisdom is to hope for stock prices to rise, there are scenarios where some investors might prefer stock prices to decrease. Understanding why this happens requires a dive into different investment strategies, market mechanisms, and psychological aspects of investing. Here’s an in-depth explanation of why some people want their stocks to decrease in value and the advantages of having stocks go down instead of up.

 

1. Short selling

 

One of the most straightforward reasons investors might want stock prices to decrease is short selling. Short selling is a trading strategy that speculates on the decline in a stock's price. Here’s how it works:

 

Borrowing shares:  An investor borrows shares of a stock from a broker.

 

Selling the shares:  The borrowed shares are sold at the current market price.

 

Repurchasing at a lower price:  The investor aims to repurchase the same number of shares at a lower price.

 

Returning the shares:  The repurchased shares are returned to the broker.

 

If the stock price drops, the investor buys back the shares at a lower price than they were sold for, pocketing the difference as profit. For example, if an investor short sells a stock at Rs.100 per share and buys it back at Rs.80, they make a Rs.20 profit per share, excluding fees and interest. This strategy allows investors to profit from falling prices, creating a direct incentive for wanting stock prices to decrease.

 

2. Buying opportunities

 

Another reason investors might want stock prices to decline is to create buying opportunities. This is particularly relevant for long-term investors who believe in the fundamental strength of a company but feel the current prices are too high. When stock prices drop, they can purchase shares at a lower cost, potentially leading to greater returns in the future as the stock price rebounds. This approach aligns with the investment principle of "buy low, sell high." For value investors who are looking for bargains in the market, a drop in stock prices can present the perfect opportunity to buy stocks that they believe are undervalued.

 

3. Dollar-cost averaging

 

   For investors using strategies like dollar-cost averaging (DCA), lower stock prices can be advantageous. DCA involves investing a fixed amount of money into a particular stock or fund at regular intervals, regardless of the stock’s price. When stock prices are lower, the fixed investment buys more shares, reducing the average cost per share over time. This strategy can lead to significant benefits when the stock price eventually rises, as the investor owns more shares purchased at lower prices. By consistently investing during market downturns, investors can lower their overall cost basis, enhancing their potential for higher returns in the long term.

 

4. Tax loss harvesting

 

   Tax loss harvesting is a strategy used by investors to reduce their tax liability. It involves selling investments that have decreased in value to offset the capital gains from other investments. By realizing losses, investors can reduce their taxable income. These realized losses can also be carried forward to offset future gains. Hence, a temporary decline in stock prices can provide a tax advantage, allowing investors to manage their portfolios more tax-efficiently. This approach is particularly useful for investors who have substantial gains elsewhere in their portfolio and need to balance their tax obligations.

 

5. Hedging and portfolio protection

 

   Some investors and institutional investors use hedging strategies to protect their portfolios against downside risk. By holding positions that benefit from a decline in stock prices, such as put options or inverse exchange-traded funds (ETFs), they can mitigate losses during market downturns. In this context, a decrease in stock prices can validate their hedging strategy and provide the intended protection. Hedging can be seen as an insurance policy for an investment portfolio, and during times of market volatility, a decline in stock prices can justify the cost and strategy of these hedges.

 

6. Psychological advantages

 

Investors can also experience psychological benefits from falling stock prices under certain conditions:

 

Market corrections and rebound opportunities:  Markets that rise too quickly are often subject to corrections. A correction can provide a healthier market environment and new entry points for investors who missed the initial rally. This perspective aligns with the idea that not all declines are bad; some are necessary for the long-term health and sustainability of the market.

 

Building patience and discipline:  For long-term investors, enduring market downturns can build patience and discipline. These traits are valuable, as they help investors avoid panic selling and maintain a focus on their long-term investment goals. Learning to stay the course during downturns can ultimately make investors more resilient and better prepared for future market fluctuations.

 

7. Company-specific reasons

 

   For investors holding large stakes in a company, lower stock prices can sometimes be advantageous in negotiations for mergers and acquisitions. If the goal is to acquire another company, a lower stock price can make the acquisition more appealing and affordable, assuming the payment involves stock rather than cash. Lower stock prices can also benefit companies that are executing stock buyback programs. By repurchasing their shares at lower prices, companies can reduce the number of outstanding shares more cost-effectively, potentially increasing earnings per share (EPS) and providing more value to remaining shareholders.

 

8. Market sentiment and opportunities for active traders

 

   Active traders and those employing contrarian strategies may seek to capitalize on market sentiment. When stock prices decline, it often creates panic and fear, leading to overselling and irrational market behavior. Savvy traders can take advantage of this by buying undervalued stocks and selling them once the market corrects itself. This approach can yield substantial profits when the market stabilizes or recovers. Traders who specialize in volatility and market timing can benefit significantly from downturns, as these periods often present opportunities to buy low and sell high in short order.

 

9. Puts and options strategies

 

   Investors who trade options may also benefit from declining stock prices. Put options, which give the holder the right to sell a stock at a specified price before a certain date, increase in value as the stock price drops. This can be a lucrative strategy for those who anticipate declines and want to hedge their investments or profit from the downward movement.

 

10. Investment in defensive sectors

 

   Some sectors, known as defensive sectors, tend to perform well during market downturns. These sectors include utilities, healthcare, and consumer staples, which provide essential goods and services that remain in demand regardless of economic conditions. Investors might prefer a decline in the overall market if they hold significant positions in defensive stocks, as these stocks often outperform during such periods.

 

Conclusion

 

   While the general objective for most investors is to see their stock holdings appreciate, there are valid reasons and strategic advantages for wanting stock prices to decrease. These include profiting from short selling, creating better buying opportunities, leveraging dollar-cost averaging, benefiting from tax loss harvesting, and utilizing hedging strategies. Additionally, psychological advantages, company-specific strategic reasons, and market sentiment manipulation by active traders all contribute to why some people might prefer stock prices to drop rather than rise.

 

   Understanding these motivations highlights the complexity of the stock market and the diverse strategies employed by different investors. It’s not just a matter of hoping for prices to go up; sometimes, the real opportunities and advantages lie in the downturns. Investors who can navigate these periods effectively can enhance their overall returns and achieve their long-term financial goals.