Basic supply and demand mechanics drive a sell-off. If demand for a stock is higher than the supply, the price will increase. If the demand is lower than the supply, the price will drop. When demand falls sharply, a sell-off may occur. Sometimes, a sell-off is specific to a certain asset, like stock or cryptocurrency. But other times, a sell-off occurs across a sector or the overall stock market.
How Does a Sell-Off Happen?
A sell-off of an individual stock can happen for several reasons. Investors may seek to offload their shares if the company misses earnings, if management scales back earnings forecasts, or if management declines to guide earnings expectations. Bad news—such as litigation, losing market share to a competitor, or not receiving approval for a widely anticipated product—can also push stock prices down. One example of a stock sell-off occurred in late September 2021, when FedEx released its earnings for the first quarter of fiscal 2022. The parcel delivery giant’s earnings were lower than it had forecast in June. Management reported that labor shortages and supply-chain disruptions had cost the company about $450 million more than expected. FedEx reduced its earnings outlook for the full year to reflect its lower-than-expected performance in the first quarter. It also declined to issue earnings-per-share (EPSs) guidance for fiscal 2022. On Sept. 21, the day that FedEx released these earnings, its shares opened at $253. But the disappointing financial performance resulted in a sell-off. The stock sank as low as $216.34 per share at one point on Oct. 5, a drop of about 14.5%. Sometimes a sell-off happens for reasons unrelated to a company’s financial performance. Consider what happened on Nov. 9, 2020, for example, when Pfizer and BioNTech announced its COVID-19 vaccine candidate was more than 90% effective. The news triggered a sell-off of Zoom and other “stay-at-home stocks.” Zoom shares were trading above $500 on Nov. 6, 2020. But just four days later, the stock closed below $400 a share. A broader stock market sell-off often occurs at times of uncertainty. Political instability, concerns about shortages or weather events, inflation, corporate earnings, and rising interest rates all can trigger a sell-off.
What It Means for Individual Investors
A sell-off can be gut-wrenching when you’re an investor, but it isn’t necessarily a reason to panic. The stock market is what’s known as a leading indicator, meaning it tells us what investors are predicting will happen—but those events may or may not come to fruition. However, because a sell-off triggers strong emotions, many investors follow the herd and sell, then buy again when the stock’s price has recovered. In doing so, they go against the fundamental “buy low, sell high” rule of investing. Sell-offs are a completely normal part of the stock market cycle. Rather than reacting when prices are sliding or have already tanked, a better approach is to proactively prepare. Building an emergency fund is one of the best ways to safeguard your finances from a sell-off. A good rule of thumb is to save at least three to six months’ worth of expenses. If you lose your job or have a major expense shortly after a market sell-off, your emergency fund could allow you to stay afloat without selling investments at a loss. If you have sufficient cash reserves, a sell-off can present a tremendous buying opportunity. If a stock you’re interested in drops below a certain price, you could create a stock watchlist and then invest. Or you could decide to invest a lump sum in a fund tracking a stock index, such as the S&P 500, if it falls to a predetermined level. Just keep in mind that even if you buy a stock during a sell-off, its price could still drop further. If you’re going to buy in a sell-off, make sure you consider the investment to be a good value and that you’re comfortable with short-term losses.
