Downgrade - Stock Evaluation Rating

Downgrade Definition


A downgrade is a lowering in the rating of a security by one of the analysts in the financial industry.  A downgrade can come about as a result of a negative change in the fundamentals or financial situation at the company.  If a downgrade comes out from a respected agency, it can wreak a short-term disaster for the stock.

Purpose of a Downgrade


These recommendations are not released on any particular schedule, but the recommendations themselves are updated as the environment for the security changes. Rating agencies will tell investors that following these upgrades/downgrades is not a trading strategy.  A downgrade is issued by agencies to protect their clients from potential risky investments. 

How are Downgrades Issued


Downgrades are issued differently at each respective agency.  Most commonly downgrades are accompanied with a change in the recommendation for the stock.  For example, a stock may go from a buy recommendation to a hold as a result of a downgrade.  The worst case scenario would be for the stock to go from a hold to a sell as a result of a downgrade.

Do Downgrades Work?


Downgrades are often a form of Monday Quarterbacking.  The problem with downgrades is that these valuations are based on the financials of the company.  Often times traders will already price in the negative news of a security, so the downgrade will only exasperate an already rough market environment.  But when you look back over the stock, say 6 months in the future, it is often higher than where the sell recommendation was given.  This is because sell recommendations are lagging indicators as the inputs (cash flow statements, balance sheets, etc.) are public information.  So if a trader is looking for an edge, he or she will not find it by following buy sell recommendations blindly.

Rating Agencies Under Fire


Rating agencies have often been the arch nemesis of traders. There have been a number of instances where good companies have been dumped simply because a rating agency put out some negative remarks. Recently the rating agency industry has been under heavy scrutiny by the government. This is as a result of the positive ratings received by a number of banking instiutions that were heavily involved in the credit default swap market.  It wasn't until after these stocks began to tank that these rating agencies finally "got it right".  This leads many people on Wall Street asking if rating agencies provide any valuable services to investors.
Tim Ord
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Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...

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