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Read More >Why do stock prices move up and down?
Ups and downs are an integral part of any stock market. But, what affects these movements in stock prices? Read on to know more
Publish Date: February 26, 2019
By: Sandhya Kannan, Head – Content
What is a stock market?
The stock market is a platform for buying and selling various financial instruments such as the shares of a company, bonds, derivatives, and mutual funds. It may have a physical existence as in case of the New York Stock Exchange or Bombay Stock Exchange, or it may be a virtual market such as NASDAQ in the US or NSE in India.
A stock market is therefore made up of various stock exchanges around the world. There are several major stock exchanges around the world, and at least one of them is open at any time of the day. Stock markets not only trade in shares and debt bonds but also in a specialized type of instruments known as futures and options, which are a promise to sell and buy at a future date.
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The role of a stock exchange in a healthy and vibrant economy cannot be overstated.
- The stock exchanges are indicators of the economic mood in the country. It reflects the confidence level that investors have in the future growth of the economy.
- The second most important role of a stock exchange is to facilitate the flow of funds from the public to companies by helping them to raise capital. Any issue of shares of a company has to happen through one or more stock exchanges. It is one of the most accepted ways of raising new capital (the other being private placement of shares).
- The third important role is to bring transparency in the finances of companies. As soon as a company passes its ownership from a private to a public ownership (definition of which varies slightly from country to country), it is forced to publish detailed annual statements (as well as half-yearly and quarterly) of its finances and performance. No action of a public company which trades in a stock market can (at least in theory) stay secret.
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What determines the stock prices?
Stock prices are updated every minute during the operating hours of the stock exchange. They continually show a change – sometimes a minute change and at times a vast difference of 10% or more. The price of a share or stock changes because of a change in demand and supply. The stock exchange is a perfect market; there are a large number of buyers and sellers and no artificial barriers to entry exist. This allows price discovery, which allows the buyers to decide whether the price of an asset as asked by the sellers is appropriate. If the buyers feel a stock is overvalued, they will not place the “buy” order, and the price will drop. If there is significant demand for the shares of a company, then the share price will go up.
For over decades, there have been issues with the operation of stock market mostly related to buyers and sellers acting as a cartel to influence the movement in the price of stocks, but within limits, it is a near-perfect mechanism. Given a time horizon of about a year or so, it also shows quite accurately the state of the economy. If an economy is growing, there is no possible way to prevent an increase in the prices of stock and vice versa.
What affects the stock movements?
- Events related to the company – The most important reason for movement of stock prices is the news from the company itself. Although not mandatory, nearly every company issues guidance for the next quarter, which reflects how the company is expected to perform. Another metric known as market expectation--how a broad segment of stock market analysts working for different brokerage houses expect a company to perform--can affect the movement of stock prices. If a company misses its guidance or falls short of expectations, the share prices sink.
- Events related to the economy – The stock market also has broad swings based on its perception of how the economy will shape up in the medium run of 2-5 years. Thus, elections have a substantial effect on the movements in stock prices. If a government that is perceived to be pro-growth is voted into power, the market rises. Global events such as political tension in the Middle East, which may choke oil supply to the rest of the world, may also affect the stock market. Besides these factors, the health of the US economy casts a long shadow over every stock market in the world. No nation is insulated from a dip in share prices on the NYSE or NASDAQ.
- Profit bookings by large institutional investors – Profit booking indicates selling off part of the portfolio and converting it to cash. It happens when institutional investors such as mutual funds and insurance companies wish to realign their portfolios with new realities or need cash to pay quarterly dividends.
- FII – In developing countries like India, Foreign Institutional Investors or FIIs play a significant role. FIIs include various foreign banks, hedge funds, and insurance companies, which have invested in India. Because of weakness in their domestic market or to shift portfolio from one nation to another, they buy and sell a massive amount of shares. This causes fluctuations in share prices.
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On a fundamental level, the continuous act of balancing the demand and supply causes movement in the stock prices. It is not possible to pinpoint a single reason that causes the stock prices to move one way or another. The most important factors include the state of the global, local, or national economy and the performance of the company. Despite this volatility, stock markets continue to be rewarding and stories about small investments yielding large returns are not uncommon!
Also read:
- Morning Capsule: Your pre-market news update
- How to identify stressed companies
- Invest in Mutual Funds
- Stock Research for Traders
- What Yoga teaches you about money and investing
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