Stock share prices go up and down throughout each trading day. What determines those price changes can seem like a mystery to those new to investing in the stock market.
On a basic level, share prices for stocks traded on public stock exchanges are determined through supply and demand, and demand is determined by expectations and emotions.
What this means is if there is less supply of a stock, there may be more demand for it since it’s more rare. In that situation, the price of the stock will rise. Conversely, if there is more supply and less demand, the stock price will decrease. If either of these trends continues for a lengthened period of time, it can lead to a bull or bear market in which there’s an ongoing trend of increasing or decreasing prices.
For example, during the COVID-19 pandemic, stocks of companies that produce goods were popular during the pandemic, and many healthcare and supply companies. Increased demand for those supplies led to increased demand for those stocks, which caused the share prices to increase.
Beyond the basic principles of supply and demand, there are other factors that contribute to changes in stock prices. In this article we’ll dive into many factors that determine share prices and price movements.
What Determines Stock Price?
A current stock price is based on a prediction of the future success of a company. If investors have reason to believe that a company will be successful in the future, they will invest in the company, causing the price of shares to increase. Similarly, if the outlook for a company doesn’t look good, investors may sell off the shares they own, causing the price to decrease.
Basically, if a few million people think that Amazon is going to be successful in the near future and that the stock price is going to go up, that will lead them to buy the stock and its price will increase.
Emotions such as fear, panic, anxiety, greed, and hope can have a significant impact on investor behavior. There are a few different ways investors try to predict the future success of companies.
Company News and Data
These predictions can be made based on reading charts and making calculations, as well as looking at news stories, company earnings and reports, and other information. News about changes in management, production, scandals, and other stories can cause share price to quickly change.
Beyond news and outlooks specifically related to companies, outside factors can also influence investor behavior. For instance, an election, a pandemic, political unrest, or signs of a recession can create panic in the market, influencing investors to sell off stock shares in order to protect from losses or put their money into safer investments.
Usually there is some up or down price movement in stock prices, and some stocks are more volatile than others. It’s rare for prices to completely stop moving. It’s also rare for prices to drastically increase or decrease suddenly, but this is what happens during a market crash.
A market crash can happen when many investors begin to sell, creating a snowball effect where more and more investors pull their money out of the stock market. At that point, the market could crash, resulting in actual losses that wouldn’t have occurred if people hadn’t sold.
Another factor that can affect stock price is company buybacks of stocks. Companies will sometimes buy back their own stock from investors, thereby reducing the supply of shares to the public. They do this in an attempt to increase stock prices. If companies issue more shares of stock, they are then increasing the supply, which can cause the price to decrease.
Primary and Secondary Markets
When some companies first start selling stock to the public, they hold an IPO, or initial public offering. At the time of the IPO, an initial share price is set and investors can begin to buy the stock at that price. After the IPO ends, the stock gets listed on stock exchanges and the price starts to fluctuate as shares get bought and sold—and supply and demand begin to play a role in share price.
When companies don’t have an IPO, their shares get bought and sold privately, in which case share price is determined between the buyer and seller.
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The valuation of a stock is made by looking at the company’s past and projected earnings, large trades made by institutional investors, overall market trends of the S&P 500, and ratios and calculations made by analysts.
Four ratios and calculations that are used to determine the valuation of a stock are price-to-earnings (P/E) ratio, price-to-book (P/B ratio), price-to-earnings-to-growth (PEG) ratio, and dividend yield. These calculations can help investors figure out whether a stock is currently under- or overvalued.
Bid and Ask Price
A share price ultimately gets determined through the bid, ask, and sale price on stock exchanges. The bid price is the maximum amount an investor will pay for shares of a stock, while the ask price is the lowest price a seller will accept. When the two prices match up, a sale is made, and that price sets the new price per share of the stock. Ultimately it gets down to what someone is willing to pay and if a stock owner is willing to sell to them at that price.
What someone is willing to pay or sell for is determined by the psychological and market factors discussed in this article. If a buyer thinks the stock is undervalued at the ask price, they will buy, and vice versa. Generally the difference between the bid and ask price isn’t very large, but if a stock doesn’t have a large trading volume it can be.
Companies that are a similar size or have a similar valuation can have very different share prices, because the number of shares each company issues can differ greatly. Because of different market caps and numbers of liquid shares, share price doesn’t say much about the actual value of the company, and one can’t use share prices to compare companies. However, the share price does reflect what investors currently think the stock of a company is worth.
How to Handle Changes in Stock Price
Attempting to time the market is extremely challenging and can result in significant losses, not to mention anxiety. Once an investor sells a stock, they are then in the difficult position of trying to figure when and whether to buy back into it at a lower price, if it even continues to decrease in value. Likewise, they could sell at what they think is the peak of the market, only to watch the price continue to rise.
Historically, the stock market has continued to rise over the long term, despite ups and downs along the way. Although past trends are never a guarantee of future outcomes, it’s likely that investors with a longer time horizon, who are willing to hold onto their stocks throughout up and down cycles, will eventually see positive returns.
That said, market volatility can provide opportunities to invest when the stock market is down, or sell at higher prices, especially if they were already considering buying or selling a stock.
Ultimately, supply and demand drive stock prices—which is informed by market conditions, world events, and investor behavior, among other influences.
Although there is no way to look into the future to predict share prices, investors tend to look at past performance, charts, and market trends to attempt to predict price movements. In general, it’s best not to try and time the market, but to focus on building a solid long-term portfolio that will grow over time.
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