Many investors enter the stock markets to tap quick and easy wealth creation opportunities.
Most of them buy and sell stocks to earn profits. However, a lot of people also tend to stay away from the stock markets or keep their investments to a minimum due to the constant market fluctuations that pose the risk of loss. Due to stock market volatilities, investors may be apprehensive about trading.
Before trading in stocks, it is best for investors to know why market volatilities arise and why stock prices change. To address these, let’s understand how stock prices are determined.
How are stock prices determined?
Stock market prices are based on the demand-supply theory. When a stock’s demand is more than its supply, its price would generally rise. The more the gap between a stock’s demand and supply, the higher its price.
For example, if investors start buying stock A, its price will likely increase. When investors start selling the same stock, its price will likely decrease. Thus, market forces or risks influence the rise or fall in a stock’s demand and supply and thereby stock prices.
Why does demand for a stock increase?
Some of the common reasons why a stock may see a rise in its demand are:
- Strategic moves announced by the company management such as new tie-ups, acquisitions, etc
- Positive news about a company (such as innovative product launch, reduction in taxes applicable to the industry, etc)
- Consistently good financial performance (such as a rise in sales, earnings, etc)
Why does demand for a stock decrease?
Here are common reasons why a stock demand may drop:
- Any negative news about the company (such as disruption in management, industry downturn expected, etc)
- Consistently poor financial performance
- Rise in debt usage
Every financial investor may have his/her own philosophy regarding a stock’s price. Some may believe that a share’s price is difficult to accurately predict while others feel that determining the future price is easy based on past track record and trends in stock price movement.
Buyers tend to be optimistic about a stock’s performance, while sellers believe that the stock is overvalued and may not fetch good returns in the future.
Why do stock prices fluctuate?
As we learnt earlier, stock price fluctuations are influenced by its supply and demand. So, what is the demand and supply of stocks?
- Supply is the total number of investors who are willing to sell their shares at a given price.
- Demand is the total number of investors who want to buy a stock at a given price.
When the number of investors willing to buy a stock (its demand) is higher than the number of investors willing to sell the stock (its supply), the stock price rises. Stock price may decrease in case the vice versa is true.
This brings us to the question, why do investors prefer to buy some stocks over others? There are various reasons that affect the demand and supply of a stock. These, in turn, result in stock price changes. Listed here are some of these factors:
a. Positive or negative news about the company
Any positive news about a company will likely result in a rise in the demand for its shares. In case of negative news, the stock demand may drop as investors try to exit the investment by selling. This further results in price fluctuations.
b. Investor preferences
As a common stock market theory goes, there are never two investors who may entirely agree on each aspect of a stock. This is because each investor is different in terms of ideas and strategies. Some people may prefer to invest in a stock while some may not. This difference in the thoughts,ideas and strategies can impact the demand for a stock and, therefore, its price. Preference can also be seasonal, resulting in price changes across different periods.
c. Psychological factors
Stock markets are often influenced by investor sentiments which are in turn driven by profit-mindset & fear. As people aim for profits by investing in a stock, its demand will see a rise and so will its price. As people become fearful about a certain investment, they may sell the stocks and exit, resulting in an increase in supply and a drop in price. Thus, investor psychology may cause fluctuations in stock prices.
d. Company performance
By looking at a company’s earnings, investors can measure its profitability. Every investor would want to invest in a profitable company. Therefore, the stock prices fluctuate as a result of changes in the present value of its expected future earnings. If earnings are expected to rise, the stock prices may rise and vice versa.
e. Additional factors
Market fluctuations are governed by many other variables, such as changes in government policies, interest rate fluctuations, institutional investor influence, international index performance, market speculations, general economic and business conditions, etc.
Changes in stock prices are a function of its demand and supply. Various factors, such as a company’s earnings, financial track record, economic conditions, etc influence an investor’s desirability to buy or sell a stock.
Every time a new transaction takes place, the stock prices can change. Most major stock exchanges experience stock price changes many times on a daily basis.
Market equilibrium is the point at which the demand and supply is the same. This means, all buyers and sellers continue to trade until an agreeable price is reached.
Market capitalization or market cap is a company’s current share price multiplied by the total number of outstanding shares of the company.
Intrinsic value of a stock is its true value calculated by considering the monetary benefit expected from it in the future. It is the maximum value that an investor is willing to pay for it without incurring a loss while selling it in the future.
Investors often use both fundamental and technical analysis to gauge the real worth of a stock before investing in it. This helps in minimising losses and maximising profits.