Stock Prices – Why They Go Up & Down
May 18, 2009
The price of a stock is determined by what people are willing to pay for it. At whatever point the demand of buyers meets the supply of sellers, the price of the stock is created. There may be someone out there trying to sell their AIG stock for $50 a share, but there are no buyers, or no demand at that price. The more important question is what pushes the stock up and down? The way I see it, the major factors fall into four categories:
- Fundamental Factors
- Technical Factors
- Market Sentiment
Stock Price Fundamental Factors
If the stock market were in a vacuum, this would be the only topic to discuss. With the absence of outside forces, a stock’s price would come down to its value and potential for earnings. When looking at these two factors, analysts use a stock’s P/E Ratio and Earnings Per Share (EPS) among others to determine the proper price of a stock. Other factors used are Cash Flow & Dividends.
Stock Price Technical Factors
Technical factors are a combination of external pressures that can change the supply and demand of a stock. These can force a stock in a particular direction regardless of the fundamentals.
Inflation is a very large factor in the stock market. Generally, low the inflation means higher valuations of the stock. The opposite can be said of high inflation.
Market & Industry Strength both play roles on a stocks price as well. If a particular stock is seen as outperforming or underperforming, the entire sector can be pulled in the same direction. Consider it guilt, or reward, by association.
Liquidity can also effect the movement of a stock. In terms of the size of a company, larger stocks generally have more liquidity than smaller stock. They respond better to news and have much higher trade volumes.
Stock Prices & Market Sentiment
The movements of the stock market over the last 18 months are a perfect example of how market sentiment can drive prices. What we saw for a large period of time was irrational fear taking over causing massive selloffs. It has driven some stocks down to small fractions of what they once were and others have disappeared altogether. As I said in my investing mistakes post, the two biggest enemies of the market are fear and greed. Both can and have caused major swings in both individual stocks and the market as a whole.
Stock Prices & News
Some may consider this a part of the previous category, but I see this as something that drives market sentiment and not necessarily something that is part of it. Imagine what would happen to the price of a stock if it were announced that the company had found a cure for cancer. What if another company found massive oil reserves inside the US borders? Using that same logic, if it was found that a food company had been distributing food with toxic ingredients…you get the point.
While this is not a complete list of driving forces, most items would fall into one of these four categories. When you’re looking at investing in a company, be sure to examine all these criteria before buying the stock.
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