Stock Price Free-fall Paradox

Due to COVID-19 pandemic, the Standard and Poor Index fell 30% within a short span of a month. This Coronavirus wreaked havoc on the investment world not to mention normal life.

While rest of the investors are scrambling to decide on what to do, we pondered on an abstract thought. We focused solely on the stock price and questioned ourselves a simple question i.e. Can a stock price fall 30% infinitely?

Can a stock price fall 30% infinitely?

Can a stock Price decline 30% forever?

The technical answer is yes.

A simple math is enough to prove the above proposition. In the example below, a $1,000 share is declined 30% to $700 and $700 is declined 30% to $490 and so on. It took us 32 declines of 30% to reach a mere penny from $1,000.

Well, the math goes on. In fact, we can continue this trend infinite times and we do not reach $0. However, we do come very close to $0, but we will never reach $0.

Stock's Free-fall Paradox
Fig – Stock Price Free-fall Paradox

It seems mind-boggling that the stocks can fall 30% forever, but still does not add up to 100%. It can easily throw non-mathematical person for a loop. Make no mistake that the decline is computed from the new discounted share price.

In the real world, when we add other variables into the factor (instead of solely discounting a stock price), in general, in a long-term, stock price follow the earning of the underlining business. If a business is not profitable for prolonged period of time, it will go under and the stock price reaches $0. Math completely disagrees with a very common sense when it comes to investing. This is the exact reason why you should refrain from doing technical analysis.

Technical analysis is a bad thing. You can stare at the stock chart all day long and see multiple cup handle signs, but it means nothing at the end.

Every stock price has an underlying business behind it. You need to focus on the very fundamentals of that business instead of focusing on the technical aspect of the stock price.

Here is what happens in the real world. In less than a month, Planet Fitness, Inc. share price dropped 69% and General Electric is down more than 78% since the 2016 high.

Planet Fitness Stock Price
Planet Fitness Share Performance Chart.
General Electric Share Price
General Electric Share Performance Chart.

If the COVID-19 forces the businesses to close for a long time, their sales evaporates and they cannot continue their operation profitably. And then the company becomes insolvent. At this stage, the common investors may get something or come empty handed based on how strong their balance sheet is.

I believe we made our point clear that the technical analysis is a bad way to go about in investing. And if we offended the technical analyst out there, it was certainly not our intention to do so. Nevertheless, the brighter side of this for ya’ll is that we coined the term “Stock Price Free-fall Paradox”. You can now adhere this in your already complicated dictionary!

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