Yesterday, Apple (NASDAQ:AAPL) shares briefly fell below the $400 mark, dropping to their lowest levels since late 2011. Yet before you fall prey to the mad media frenzy that the milestone-breach created, step back and remember that every analyst, news source, and other so-called expert that drew any huge conclusions from Apple's short-term movements was guilty of making a simple mistake: anchoring their views on the stock to a particular price.
The meaninglessness of $400
Anchoring is a common practice among investors. Whenever you draw an arbitrary line in the sand for a particular financial metric such as a stock price or index level, you're anchoring your perspective on that stock to your chosen number, even if it's based on nothing other than psychology. Anchoring reflects the behavioral need to try to take the chaos of the stock market and draw seemingly orderly conclusions, even if they're based only on the initial arbitrary anchor.
Of course, the more people anchor to a particular figure, the more important it becomes to the overall psychology behind the stock. For instance, many investors pay close attention to whether a stock's price is above or below what they paid for the stock. Yet most of the time, since every investor paid different prices for their particular shares, my anchor will bear no resemblance to your anchor, making them largely irrelevant as a predictor of group behavior.
By contrast, sometimes big groups of people come to the same conclusions and anchor to the same level. That happened with Facebook (NASDAQ:FB) in its IPO, where $38 per share still represents a huge line in the sand based on its initial offering price. If enough people decide that Facebook hitting $38, Apple falling to $400, the Dow hitting a new record high, or gold dropping below $1,400 per ounce represents some sort of special turning point, then what happens at those levels can turn into a self-fulfilling prophecy.
What's really important
To avoid making mistakes based on anchoring, it's critical to remember that fundamental events rather than arbitrary milestones are responsible for changes in the intrinsic value of the companies you invest in. So if yesterday's announcement from Cirrus Logic truly reflects a drop in long-term demand for Apple's products, then its decline may be justified, even if the coincidence of its decline to $400 is irrelevant. If Facebook can monetize its mobile platform and build profit, then climbing from current levels to $38 per share may be just a stepping stone to even larger future gains. If stories that Cypriot central bankers may need to sell off bullion reserves prompted investors in SPDR Gold (NYSEMKT:GLD) to dump their gold holdings and flood the market with a glut of supply in the face of weak demand, then the big decline in gold prices earlier this week makes perfect sense. But don't make the mistake of thinking that the particular levels they hit along the way are necessarily an exact reflection of those fundamental changes.
Experienced investors are constantly on guard to avoid emotional responses to market movements. Being aware of the temptation to anchor on meaningless metrics will help you avoid making false conclusions from them.
Fool contributor Dan Caplinger owns shares of Apple. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Apple and Facebook. The Motley Fool owns shares of Apple, Cirrus Logic, and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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