Ted Allrich is the founder of The Online Investor and author of the just released book: Comfort Zone Investing: Build Wealth And Sleep Well At Night. In this weekly column, he'll offer advice to investors who are just getting started.August can be one of the most volatile months for the stock market. That's because many investors are on vacation and with fewer buyers or sellers in the market, stocks can do funny things.
For example, if a large institution wants to get out of a stock that doesn't trade very much, the price will go down to a level where buyers will buy it. That's standard on any day of the year. But in August, if that same seller is determined to sell, the level to find buyers may be much lower than most other months because many potential buyers are gone. They're out of the office. They can't be reached while they float down the river or are on top of the roller coaster ride. Even with cell phones and email alerts, many investors turn off all communication so they can have some uninterrupted time with their families.
So some stocks that you watch trade in an orderly way may be hit much harder over the next couple of weeks as trading volume in that particular stock thins out or picks up. If it thins out, it means fewer buyers and sellers are interested and spreads (the difference between the bid and ask on a stock) will widen. It is harder to sell stocks in thin markets because a bid is sometimes only good for 100 shares, then the market maker or specialist takes it lower, only to buy 100 more shares before lowering it again. If it's only the market maker or specialist buying the stock, it will sink very fast since they don't like to use their own capital to hold stocks. They will drop the price to find a real buyer, someone who wants to own the stock, so they don't have to take the risk of having the stock in their possession if bad news breaks.
The same is true on the buy side. If you're an investor trying to accumulate a lot of shares in one stock, you may see the price move up very quickly as you try to buy a large amount. That's because a lack of sellers means the specialist or market maker has to "short" the shares (sell shares they don't own) and then buy those back. If they are short and there's good news on the stock, it could run up very quickly, away from them and cost a small fortune as they scramble to buy back shares to cover their shorts.
There can be some tremendous moves in August. We've seen what that looks like on the downside this month already. But there can also be tremendous surges on the upside. In August of 1985, the market had a huge rally, then kept going for about 15 years.
August is almost as cruel as October for investors. With lighter volume due to fewer investors, wild swings are often part of the market. Sometimes individual stocks can behave seemingly irrational, with price gyrations guaranteed to get your heart beating faster. Most of the time that's because one seller or one buyer wants to do something in a big way and is willing to force the market to accommodate. It will but at a very dear price. Unless there's printed news, especially bad, on a specific stock you own and under selling pressure, it may be because of just one institution that wants out. After that stock has found a new home, oftentimes the price bounces right back to the level it traded before the stock hit the fan.
It's August. Beware. Be wary. Be patient.
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Closing Bell: What sell-off? (AIG, ABK, EPR, MBI, JAVA, ORCL, ERTS)
