Sell-Off: Definition, How It Works, Triggers, and Example

What Is a Sell-Off?

A sell-off occurs when a large volume of securities is sold in a short period. A sell-off causes the price of a security to fall in rapid succession. As more shares are offered than buyers are willing to accept, the price decline may accelerate as market psychology turns pessimistic. Sell-offs may be triggered by the release of disappointing earnings reports or poor guidance, fears of increased competition, or the threat of technological disruption. Broader causes, such as macroeconomic concerns or natural disasters, can also trigger sell-offs.

How Sell-Offs Work

A sell-off occurs when investors sell a large volume of their shares in a short time. As noted above, a sell-off leads to prices dropping dramatically as selling occurs. Sell-offs are based on the principle of supply and demand. If a large number of investors decide to sell their holdings without any compensating increase in buyers, the price of that investment will fall.

Sell-offs are a reflection of investor psychology. For instance, if a sell-off occurs after a new earnings report, the sellers may have been overly optimistic about that security when they bought it beforehand.

For contrarian investors, sell-offs can present an opportunity to buy at low prices. If investors believe that the sell-off was unwarranted or overly extreme, they might take the opportunity to buy the security at a “bargain” price.

What Triggers a Sell-Off

A sell-off doesn't just occur on its own. Rather, it takes place when certain events take place. The following situations are examples of what may trigger a sell-off:

• After the market closes, a company gives sharply lower earnings guidance for the current fiscal year. A steep sell-off of the company shares generally occurs in after-hours trading.
• A news report spreads quickly during the trading day that a restaurant's customers contracted E. coli. The restaurant chain's stock sells off as the market believes that the company's earnings will be severely impacted.
• A higher-than-expected inflation report is released in Germany, which triggers a sell-off in German bunds.
• China surprises the global market by providing a growth rate forecast for its gross domestic product (GDP) that is well below expectations. A major sell-off in many basic commodities takes place.
• A rumor during regular market hours that a company will announce a highly dilutive acquisition prompts a sell-off. The company releases a statement refuting this, which leads the stock to make a quick U-turn and head back up.
  

Sell-Off vs. Rally

A sell-off is the opposite of a market rally. While a sell-off refers to a drop in prices and a rapid sale in shares, a rally occurs when there is a rapid increase in prices in a short amount of time. Put simply, it is an upswing in the markets.

Like sell-offs, rallies can be triggered by one or more factors. Rallies can be triggered by an increase in demand, which boosts share prices higher. Some of the underlying causes of a rally include news issued by companies, positive earnings releases, shuffles in corporate management/leadership, regulatory changes, and new product launches among others.

Example of a Sell-Off

A notable example of a sell-off occurred in April 2010 during the Deepwater Horizon oil spill. During that month, the offshore drilling platform exploded off the coast of Louisiana, discharging about four million barrels of oil into the Gulf of Mexico.

This event had a major environmental impact and affected British Petroleum (BP) shareholders. In the months following the oil spill, BP’s shares lost over 50% of their value, spurred by a hundredfold increase in selling volume. Understandably, investors were fearful of potential fines and legal consequences.

The event cost BP $65 billion in fines and settlements, leading to a quarterly loss of $17 billion in July 2010. By November 2010, BP’s financial performance showed signs of recovery, ending the quarter with a profit of $1.8 billion.

The share price recovered about half of its losses by year-end. For many contrarian investors, this sell-off provided an attractive buying opportunity. Those who went against the grain and purchased BP’s shares at their most depressed prices saw their shares rise by over 30% by the end of the year.

The Bottom Line

As an investor, you may be tempted to jump on the bandwagon during a sell-off. Letting your emotions get the better of you may put you in a worse position than if you keep the stock. Remember not to give in to panic, as this can often lead to bigger losses. Take your time to weigh your options and do your research before making any major moves.