Bad Things Happen on the Downside

One reason that stocks decline in price is the occurrence of events that investors view as bad. For example, a decline in earnings, sales, or profit margins can cause a stock to drop in price. The indictment of a company executive for criminal activities or fraudulent accounting practices can cause a sell off. A market can move to the downside because of negative economic news brought on by a slowing economy. If the economy continues to be sluggish, stocks can decline for a prolonged period of months, a few years or even many years. That's why buying on the downside is not wise. Bad news has a tendency to beget more bad news. And falling prices tend to keep falling.

What investors dislike even more than bad news is unexpected bad news.That's what happened on September 30, 2004 after Merck (MRK) announced that it would pull Vioxx, its leading arthritis drug, from the market. On that day the stock fell from $45.07 to $33, a -26.78% decline, on very heavy volume. Even though the stock had been on the downside since it had peaked on December 28, 2000 at $81.25 investors elected to bring it down more as they learned of the Vioxx bad news.

Has MRK bottomed at $33? No one knows. But it's still on the downside so the prudent investor would not buy the stock. Avoiding the downside is your protection against losing money.