Asking yourself, “How are stock prices determined?” Having a good understanding of the movements of stock prices is one of the keys to becoming a successful stock trader. However, predicting stock prices is by no means an easy task, especially for new traders. One thing you can do to make more accurate price forecasts is to try to understand what makes stocks go up and down. In your quest to discover what causes stock prices to change, you have to take a variety of factors into consideration, from the sentiments of traders to random events. Below is a comprehensive look at how stock prices are determined.
Stock prices can change because of many factors, including:
- Fundamental factors
- Demand and supply
- Financial health of a company
- Management or production changes
- Reputation of a company
- Industry factors
- Economic health of a country
- Tragic events
- National or global news
What Are Stock Prices?
Before you try to understand what makes a stock go up or down, it’s important to know the exact definition of a stock price. A stock price is the current price of a share of a company’s stock. It’s the price a buyer is willing to pay for one share at a particular time. Bear in mind that the price of a stock is different from its value. Stock value represents the value of a company. There’s a variety of performance-related factors that can affect a company’s stock value, including its past and present earnings, sales, and market share.
You should also know that there are two types of stock price: bid price and asking price. A bid price is the price a buyer is willing to pay for a share of stock, while an asking price is the price at which a company is willing to sell a share of its stock.
Likewise, there are two types of stock value: quoted market value and intrinsic value. Also known as current market value, quoted market value is the value of a stock the buyer and seller agree upon. Intrinsic value, on the other hand, is the current net value of a company’s stock, which is based on the potential income the company can generate indefinitely.
Why Do Stock Prices Change?
Sometimes, the price and value of a stock are the same or within the same range. However, there are many factors that can cause the price of a stock to be higher or lower than its intrinsic value. Below is a list of factors that can have an impact on stock prices.
In an efficient stock market where all relevant information has been applied, fundamental factors will determine stock prices. These factors comprise two aspects: earning per share and earning potential of shares. The higher the earning per share and earning potential of shares, the higher the stock prices, and vice versa. Changes in these aspects are one of the things you need to consider when trying to understand what makes a stock price go up or down.
Demand and Supply
The law of demand and supply is one of the main driving forces behind market prices. Aside from commodity prices, it can also have an effect on stock prices. When a company’s products or services are in high demand, its stock will become more desirable, causing it to go up. Conversely, if the demand for its products drops, the price of its stock will go down. The decrease in the stock price will be significant if the demand is much lower than the supply. If the supply balances out the demand, the stock price will be stable.
Financial Health of a Company
A company’s financial health is another major factor influencing the price of its stock. When you buy shares, you’re actually investing in a company in the hope that its stock price will rise as it becomes financially stronger. Therefore, investors are willing to pay a higher price to invest in a company with healthy financials. On the other hand, they’ll think twice about buying the shares of a company with poor financials, even at a lower price.
Many factors that affect a company’s financial status can have an effect on the price of its stock. For example, new product launches, mergers, and acquisitions can cause its stock price to go up, because they can lead to greater profits. Factors such as competitors’ product launches, loss reports, massive layoffs, and loss of market share will cause a company’s stock price to drop.
Management or Production Changes
Internal changes within a company can also lead to a change in its stock price. Management changes have an especially significant impact. For example, the loss of a strong CEO can be a big concern to investors. This can result in panic selling and cause the company’s stock price to fall. In contrast, a company that gains strong leadership can inspire confidence among investors. Since the positive change is likely to lead to an increase in revenue, the price of its stock will go up.
Production changes can also affect a company’s stock price. Changes that increase its production efficiency and quality will boost the price of its stock, while factors that undermine its production capability will cause its stock to fall.
Reputation of a Company
When you’re trying to understand what determines stock price, you should also look at the reputation of a company. A popular company that gets positive mentions on social media or the news will attract more investors, which will drive up its stock price. On the other hand, a start-up that isn’t well-known is likely to have a lower stock price. Publicity can also affect stock prices. Good publicity, such as rumors of a breakthrough, can cause the price company’s stock to rise, while scandals can result in a dramatic drop in its stock price.
Before buying a company’s shares, investors will look at the status of its industry. If there’s a huge potential for growth, the company’s stock is bound to go up. However, if there’s a risk of the industry failing, its stock will fall. A good example of how industry factors affect stock prices is the implosion of the telecommunication industry in the 1990s. Due to the dawn of the internet, investors predicted huge growth in the telecommunication industry. As a result, several telecommunication companies saw a significant increase in their stock prices.
Industry factors can influence stock prices regardless of a company’s financial status. For example, a strong company that’s operating in a risky industry may have a low stock price, while a weaker company in a strong industry can have a higher stock price.
Economic Health of a Country
The economic strength of a nation is another reason why stock prices change. Most investors rely on economic indicators to make sound trading decisions. If the economy is healthy, you can expect the stock prices of certain companies to rise. These companies are likely to generate more revenue as consumer confidence increases. On the other hand, some companies’ stock prices will fall during tough economic times.
If you’re wondering what affects stock price movements the most, tragic events are one of the top factors. These events can have a devastating impact on the stock market as a whole or on specific companies. Some examples of such events include terrorist attacks, airplane crashes, fires, and earthquakes.
An example of a tragic event that sent the stock market into turmoil was the Sep. 11, 2001 attacks. The 9/11 attacks led to chaos and panic selling in the New York Stock Exchange, which consequently experienced one of its worst declines in history. Companies that owned the planes used in the attacks saw a huge drop in their stock prices. The stocks of other airline companies, aircraft manufacturers, and insurance companies also went down significantly.
National or Global News
How do stocks go up or down because of national or global news? The answer is speculative investment. Many expert investors analyze news events around the world before making investment decisions. As a result, these events can influence the movements of stock prices. For example, news about layoffs, strikes, and economic slowdowns can cause stock prices to drop. Conversely, news about subsidies, tax cuts, and breakthroughs are likely to lead to an increase in stock prices. The extent and duration of the price changes depend on the impact of the news events.
If you’re wondering, “Why do stocks go up and down?” there are many factors to consider. Knowing the reasons why the price of a certain stock is rising or falling enables you to gain a better understanding of its profit and risk potential. This can help you determine whether the stock is worth investing in. If you want to learn more about stock trading, don’t hesitate to download our free trading handbook, which contains valuable tips and tricks from our millionaire trading experts.