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One of the single most important things to understand when you’re trying to work out the stock market, is the concept of “expectations”. At any given moment, it is the expectations of the masses which determines the price of a stock. So what does that actually mean? OK, lets discuss…
We here at 5 Minute are HUGE fans of the Bourne movies. Simply, they are tremendous. Filled with unbelievable action sequences, a beautiful man and supreme dialogue. With each movie came increased expectations of the next one’s awesomeness. ‘The Bourne Identity’ was amazing, which meant expectations were high when they announced the sequel, ‘The Bourne Supremacy’. Thankfully, it was. But that only meant our hopes were higher still, come the announcement of the third instalment of the series ‘The Bourne Ultimatum’. As expected it was excellent. Then they announced the fourth film, ‘Jason Bourne’…. After 9 years of “will they or wont they” make another one, they did. 9 years of anticipation. 9 years of excitement. We went, we saw, we left disappointed.
Objectively you may say that the film was good. And perhaps it was, but with expectations so high, we were always bound for disappointment.
Say the movie was a 7 out of 10, but our expectation was a 10/10. Well, there’s a big gap between fact and expectations, which needs to be corrected. And that is what happens in the stock market all the time.
Sometimes when things are good, they are actually bad….
Think of the score out of 10 for a movie as the its stock price. Our expectations for the fourth instalment meant that we were willing to pay $10 to go and see it (ie expectations of 10/10), but then afterwards we realised it was only worth $7 (ie 7/10). So Bourne’s stock price effectively “fell” by $3. So even though 7/10 was a good “result”, it was below our expectations, so the price fell.
….and sometimes when things are bad, they are actually good
If instead, we were going to see some Adam Sandler movie, our expectations would rightfully be low, given his history of bad films (see here). Probably a 3 out 10 (ie $3). Say after seeing it though, we gave it a 4/10 (ie $4), acknowledging it was poor, but not quite as bad as expected. In finance speak, the “result” came in ahead of expectations, and therefore the price went up!
In the real world
Expectations is a super important topic to get your head around. It’s the reason Apple can announce it sold 50,000,000 iPhones in three-month period, only to see its share price fall immediately afterwards! Expectations are also the reason a company can announce loss yet see its share price rise…
We’ll write a lot more about this. But for now, that’s 5 minutes. We hope it helped.