Stock market prices are affected by business fundamentals, company and world events, human psychology, and much more.
Stock trading is driven by psychology just as much as it is by business fundamentals, believe it or not. Fear and greed are the two of the strongest human emotions that affect the market. For example, it is easy to get caught in the trap of selling a stock prematurely because it dipped temporarily and fear set in. On the other hand, it is also easy to miss out on a respectable gain because greed was telling you to hold out for more, and then the stock drops back down.
Anyone who is considering investing in the stock market will hopefully be aware that the share price of individual companies can go up and down, as can whole sectors of the market or sometimes the whole market can go down in value. There are a large number of factors that can influence the share price of a company.
One of the main business factors in determining a stock's price is a company’s earnings, including the current earnings and estimated future earnings. News from the company and other national and world events also plays a large role in the direction of the stock market. Some examples of this are oil prices, inflation, and terrorist attacks.
The share price of a company is effectively the limit of what an investor is prepared to pay for it. If investors are confident that the stock of a company is undervalued demand will increase and the price will increase until those investors who own the stock feel the price is worth selling for. At this point supply and demand will balance out and the price will stabilize until something happens to convince investors to increase demand again. The reverse of this is where supply is greater than demand and those wishing to sell have to lower their price until demand increases.
Not all investors study financial reports and some buy shares simply because the prices are increasing and they feel they are bound to increase more. When the prices are increasing like this it is known as a bubble. When the bubble inevitably bursts shares return to a value based on the profitability of the company. A large bubble can affect whole sectors or even the whole market in an extreme case. The reverse of a bubble where investors are selling and prices drop below their logical price is known as a crash.
The individual fortunes of a company are mainly measured in terms of the profit it makes and the possibility for future profits. Listed companies have to provide reports of their profits publicly and it is common to see big moves in prices if the reported profits are different to those expected. Other factors that can affect the price include key directors joining or leaving the company, contacts being won or lost and rumors of a takeover or merger.
As well as the fortunes of the individual company, the fortunes of the sector as a whole are likely to affect the price. Investors and the financial press group companies into sectors such as construction or aviation and a change in the demand for their sector or the raw materials and commodities they rely on can move the prices of all the companies in the sector.
Wider economic activity can have an effect on the share price of a company even when it is not directly affected. In a recession when people have less money to spend and are concerned about the risks of investing in the markets the demand for the stock of a company can be reduced which will push the price down. Large nationwide and global events can also cause a similar effect for example when the New York Stock Exchange opened for the first time after 9/11 the whole market suffered its worst ever loss in a day.
Natural disasters can also cause drops in share prices as concerns over likely price increases in commodity and raw materials. Government policy and perceived policy changes including upcoming elections can also affect prices where conditions for business are likely to change.
Apart from those discussed above, the following one’s too are also factors for price variations, such as,
Bad News or "Good" Bad News?
Company news and performance
Here are some company-specific factors that can affect the share price:
Industry performance
Often, the stock price of the companies in the same industry will move in tandem with each other. This is because market conditions generally affect the companies in the same industry the same way. But sometimes, the stock price of a company will benefit from a piece of bad news for its competitor if the companies are competing for the same market.
Market Scandals
Traders tend to frown upon corruption in the stock market. Mutual fund scandals that have occurred in the past few years and corporate corruption such as Enron are two such examples. If people cannot trust the stock market, why would they invest their hard-earned money in it? In these situations it is harder for the market to go up because there is a lower demand for stocks.
Investor sentiment
Investor sentiment or confidence can cause the market to go up or down, which can cause stock prices to rise or fall. The general direction that the stock market takes can affect the value of a stock:
Changes around the world can affect both the economy and stock prices. For example, a rise in energy costs can lead to lower sales, lower profits and lower stock prices. An act of terrorism can also lead to a downturn in economic activity and a fall in stock prices.
Changes in economic policy
If a new government comes into power, it may decide to make new policies. Sometimes these changes can be seen as good for business, and sometimes not. They may lead to changes in inflation and interest rates, which in turn may affect stock prices.
Interest rates
The Reserve Bank of India can raise or lower interest rates to stabilize or stimulate the Indian economy. This is known as monetary policy. If a company borrows money to expand and improve its business, higher interest rates will affect the cost of its debt. This can reduce company profits and the dividends it pays shareholders. As a result, its share price may drop. And, in times of higher interest rates, investments that pay interest tend to be more attractive to investors than stocks.
Economic outlook
If it looks like the economy is going to expand, stock prices may rise. Investors may buy more stocks thinking they will see future profits and higher stock prices. If the economic outlook is uncertain, investors may reduce their buying or start selling.
Inflation
Inflation means higher consumer prices. This often slows sales and reduces profits. Higher prices will also often lead to higher interest rates. For example, the Bank of Canada may raise interest rates to slow down inflation. These changes will tend to bring down stock prices. Commodities however, may do better with inflation, so their prices may rise.
Watch this video to learn more about inflation.
Deflation
Falling prices tend to mean lower profits for companies and decreased economic activity. Stock prices may go down, and investors may start selling their shares and move to fixed-income investments like bonds. Interest rates may be lowered to encourage people to borrow more. The goal is increased spending and economic activity. The Great Depression (1929-1939) was one of the worst periods of deflation ever.
Analyst Recommendations
Many traders rely on experts' opinions about companies and future stock prices. Are they always correct? Of course not. Nobody can predict what will happen in the future. They can, however, make educated guesses based on past performances and future prospects for the companies and industries they follow.
Round Numbers
Traders often like nice round numbers for their perceived stock price, such as $10.00 or $35.00. It is common for prices to settle near these round numbers, at least briefly. Also, many traders place automatic buy or sell orders right near these round numbers, causing the stock price to become slightly erratic when it first reaches that target.
Technical Analysis
One of the most popular methods for helping predict a stock's price, at least in the short term, is called Technical Analysis. This method involves looking for patterns or indicators in stock prices, volumes, moving averages, and many others, over time. Obviously nobody can predict the future but this method can be effective in many cases because human beings are somewhat predictable. For example, when people see a stock start falling dramatically they often panic and sell their positions without investigating what caused the fall. This causes even more people to sell their shares and this often leads to an "overshoot" of the stock price. If you believe the price went too far down you can try to buy it at the bottom and hope that it will come back up to a more reasonable level.
Another common example involves Moving Averages. Many traders like to chart the 50-day and 200-day Moving Averages of their stock prices along with the prices themselves. When they see the current price cross over one of these Moving Averages on the charts it can be an indicator of a change in a long-term trend and it may be time to buy (or sell) the stock.
Layoffs
This is usually good for the company and its stock price because expenses will be reduced significantly and quickly. This should help increase earnings right away. It is not always a major warning sign; it could just be a reaction to a slower economy. It is one of the quickest ways a company can cut expenses if sales have not been meeting expectations.
Store Closings
This event often causes the stock price to go up for the same reasons as layoffs. However, this is not always the case. Closing stores actually requires a lot of money, and the positive effects of it do not take place immediately. This could be a sign that the company is truly in trouble at the moment. They probably have lower sales and higher expenses than they want, possibly due to a slowdown in the industry or the overall economy. The good news is that their management is being pro-active about maintaining profitability. Unfortunately, the stock price may go down for the next few months.
Firing of CEO or Company Official(s)
This may sound very negative at first, but it does show that the company’s board of directors was bold enough to take drastic actions to help the company in the long run. The stock price could go up or down after this announcement, depending on the situation. In some cases this event could be a sign of corruption that reaches beyond these individuals and there could be more negative announcements to come.
Every analyst and trader has a different perception of what that stock price should be now and where it might be in the future, and trading decisions are made accordingly.
Stock trading is driven by psychology just as much as it is by business fundamentals, believe it or not. Fear and greed are the two of the strongest human emotions that affect the market. For example, it is easy to get caught in the trap of selling a stock prematurely because it dipped temporarily and fear set in. On the other hand, it is also easy to miss out on a respectable gain because greed was telling you to hold out for more, and then the stock drops back down.
Anyone who is considering investing in the stock market will hopefully be aware that the share price of individual companies can go up and down, as can whole sectors of the market or sometimes the whole market can go down in value. There are a large number of factors that can influence the share price of a company.
One of the main business factors in determining a stock's price is a company’s earnings, including the current earnings and estimated future earnings. News from the company and other national and world events also plays a large role in the direction of the stock market. Some examples of this are oil prices, inflation, and terrorist attacks.
The share price of a company is effectively the limit of what an investor is prepared to pay for it. If investors are confident that the stock of a company is undervalued demand will increase and the price will increase until those investors who own the stock feel the price is worth selling for. At this point supply and demand will balance out and the price will stabilize until something happens to convince investors to increase demand again. The reverse of this is where supply is greater than demand and those wishing to sell have to lower their price until demand increases.
Not all investors study financial reports and some buy shares simply because the prices are increasing and they feel they are bound to increase more. When the prices are increasing like this it is known as a bubble. When the bubble inevitably bursts shares return to a value based on the profitability of the company. A large bubble can affect whole sectors or even the whole market in an extreme case. The reverse of a bubble where investors are selling and prices drop below their logical price is known as a crash.
The individual fortunes of a company are mainly measured in terms of the profit it makes and the possibility for future profits. Listed companies have to provide reports of their profits publicly and it is common to see big moves in prices if the reported profits are different to those expected. Other factors that can affect the price include key directors joining or leaving the company, contacts being won or lost and rumors of a takeover or merger.
As well as the fortunes of the individual company, the fortunes of the sector as a whole are likely to affect the price. Investors and the financial press group companies into sectors such as construction or aviation and a change in the demand for their sector or the raw materials and commodities they rely on can move the prices of all the companies in the sector.
Wider economic activity can have an effect on the share price of a company even when it is not directly affected. In a recession when people have less money to spend and are concerned about the risks of investing in the markets the demand for the stock of a company can be reduced which will push the price down. Large nationwide and global events can also cause a similar effect for example when the New York Stock Exchange opened for the first time after 9/11 the whole market suffered its worst ever loss in a day.
Natural disasters can also cause drops in share prices as concerns over likely price increases in commodity and raw materials. Government policy and perceived policy changes including upcoming elections can also affect prices where conditions for business are likely to change.
Apart from those discussed above, the following one’s too are also factors for price variations, such as,
Bad News or "Good" Bad News?
Company news and performance
Here are some company-specific factors that can affect the share price:
- news releases on earnings and profits, and future estimated earnings
- announcement of dividends
- introduction of a new product or a product recall
- securing a new large contract
- employee layoffs
- anticipated takeover or merger
- a change of management
- accounting errors or scandals
Industry performance
Often, the stock price of the companies in the same industry will move in tandem with each other. This is because market conditions generally affect the companies in the same industry the same way. But sometimes, the stock price of a company will benefit from a piece of bad news for its competitor if the companies are competing for the same market.
Market Scandals
Traders tend to frown upon corruption in the stock market. Mutual fund scandals that have occurred in the past few years and corporate corruption such as Enron are two such examples. If people cannot trust the stock market, why would they invest their hard-earned money in it? In these situations it is harder for the market to go up because there is a lower demand for stocks.
Investor sentiment
Investor sentiment or confidence can cause the market to go up or down, which can cause stock prices to rise or fall. The general direction that the stock market takes can affect the value of a stock:
- bull market – a strong stock market where stock prices are rising and investor confidence is growing. It's often tied to economic recovery or an economic boom, as well as investor optimism.
- bear market – a weak market where stock prices are falling and investor confidence is fading. It often happens when an economy is in recession and unemployment is high, with rising prices.
Changes around the world can affect both the economy and stock prices. For example, a rise in energy costs can lead to lower sales, lower profits and lower stock prices. An act of terrorism can also lead to a downturn in economic activity and a fall in stock prices.
Changes in economic policy
If a new government comes into power, it may decide to make new policies. Sometimes these changes can be seen as good for business, and sometimes not. They may lead to changes in inflation and interest rates, which in turn may affect stock prices.
Interest rates
The Reserve Bank of India can raise or lower interest rates to stabilize or stimulate the Indian economy. This is known as monetary policy. If a company borrows money to expand and improve its business, higher interest rates will affect the cost of its debt. This can reduce company profits and the dividends it pays shareholders. As a result, its share price may drop. And, in times of higher interest rates, investments that pay interest tend to be more attractive to investors than stocks.
Economic outlook
If it looks like the economy is going to expand, stock prices may rise. Investors may buy more stocks thinking they will see future profits and higher stock prices. If the economic outlook is uncertain, investors may reduce their buying or start selling.
Inflation
Inflation means higher consumer prices. This often slows sales and reduces profits. Higher prices will also often lead to higher interest rates. For example, the Bank of Canada may raise interest rates to slow down inflation. These changes will tend to bring down stock prices. Commodities however, may do better with inflation, so their prices may rise.
Watch this video to learn more about inflation.
Deflation
Falling prices tend to mean lower profits for companies and decreased economic activity. Stock prices may go down, and investors may start selling their shares and move to fixed-income investments like bonds. Interest rates may be lowered to encourage people to borrow more. The goal is increased spending and economic activity. The Great Depression (1929-1939) was one of the worst periods of deflation ever.
Analyst Recommendations
Many traders rely on experts' opinions about companies and future stock prices. Are they always correct? Of course not. Nobody can predict what will happen in the future. They can, however, make educated guesses based on past performances and future prospects for the companies and industries they follow.
Round Numbers
Traders often like nice round numbers for their perceived stock price, such as $10.00 or $35.00. It is common for prices to settle near these round numbers, at least briefly. Also, many traders place automatic buy or sell orders right near these round numbers, causing the stock price to become slightly erratic when it first reaches that target.
Technical Analysis
One of the most popular methods for helping predict a stock's price, at least in the short term, is called Technical Analysis. This method involves looking for patterns or indicators in stock prices, volumes, moving averages, and many others, over time. Obviously nobody can predict the future but this method can be effective in many cases because human beings are somewhat predictable. For example, when people see a stock start falling dramatically they often panic and sell their positions without investigating what caused the fall. This causes even more people to sell their shares and this often leads to an "overshoot" of the stock price. If you believe the price went too far down you can try to buy it at the bottom and hope that it will come back up to a more reasonable level.
Another common example involves Moving Averages. Many traders like to chart the 50-day and 200-day Moving Averages of their stock prices along with the prices themselves. When they see the current price cross over one of these Moving Averages on the charts it can be an indicator of a change in a long-term trend and it may be time to buy (or sell) the stock.
Layoffs
This is usually good for the company and its stock price because expenses will be reduced significantly and quickly. This should help increase earnings right away. It is not always a major warning sign; it could just be a reaction to a slower economy. It is one of the quickest ways a company can cut expenses if sales have not been meeting expectations.
Store Closings
This event often causes the stock price to go up for the same reasons as layoffs. However, this is not always the case. Closing stores actually requires a lot of money, and the positive effects of it do not take place immediately. This could be a sign that the company is truly in trouble at the moment. They probably have lower sales and higher expenses than they want, possibly due to a slowdown in the industry or the overall economy. The good news is that their management is being pro-active about maintaining profitability. Unfortunately, the stock price may go down for the next few months.
Firing of CEO or Company Official(s)
This may sound very negative at first, but it does show that the company’s board of directors was bold enough to take drastic actions to help the company in the long run. The stock price could go up or down after this announcement, depending on the situation. In some cases this event could be a sign of corruption that reaches beyond these individuals and there could be more negative announcements to come.
Every analyst and trader has a different perception of what that stock price should be now and where it might be in the future, and trading decisions are made accordingly.
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