Market forces cause daily changes in stock market prices. In other words, supply and demand cause the share prices to vary day by day. If less people want to sell (supply) a stock as opposed to buy (demand) the market price will rise. On the contrary, if more people wanted to buy rather than sell the price would fall as the supply would exceed the demand.
It is easy to understand the concept of supply and demand. However the difficulty lies in why people prefer one stock over another, this result in trying to determine what aspects are positive for a company versus the negative. Every investor has their own theories as to this theory.
With this understood, the main theory in the stock market is that the movement in stock price is an indicator of the company’s worth in the eyes of the investor. You should never correlate a company’s actual value with the stock price. Market capitalization is the term for the company’s worth. The stock market price is multiplied by the number of outstanding shares. For instance, a company which trades at $100 a share, with h1 millions outstanding shares actually has a smaller value than that company which has 5 million outstanding shares and trades at $50 ($50 times 5 million equals $250 million while $100 ties 1 million only equals $1 millions) To complicate things even further, stock prices reflects future growth anticipated by the investors in addition to the company’s current market value.
Earnings are the most important factor that contributes to a company’s market value. As earnings are the profits generated by the company, no company can survive without earnings, which makes total sense in the long run. A company that does not turn a profit will not stay in business. Public companies are required by law to report their earnings quarterly (four times a year). These times, referred to as earning seasons are a crucial time for Wall Street, as this is
the basis on which they predict a company’s future value. The market price will rise if the company’s results are better than anticipated, or “surprise” while if they “disappoint” or are worse than expected the market price will inevitably fall.
Of course, earnings are not the only factor that can affect a stock value. This would make things way too easy! For example, during the dotcom bubble, there was a rise in market capitalization in the amount of billions of dollars without result in even minimal profits. We all know these values did not last as most web markets thus saw their values drastically decreased to only a fraction of their anticipated highs. However, the fact that these values moved in any direction indicates that factors other than earnings have an impact on the stock market There are literally hundreds of rations, indicators and variables that affect the market value of a stock.. Some of you may be familiar with the term price/earnings ratio. And there are other more obscure and complex terms such as “moving average convergence divergence” or “Chaikin oscillator.”
So what causes stock prices to change? To be honest, no one knows the exact science as to why the market fluctuates the way they do. There are those that believe it is impossible to predict how a stock value will change. Yet there are others that think by analyzing charts and looking at past movements you can make an accurate determination of when to buy and/or sell. The only thing we know for certain is that stocks are extremely volatile and the prices can change often and quite rapidly.
The important things to grasp about this subject are the following:
Here are a few important facts to remember about this topic:
1. Supply and demand is basically what drives the price of stock
2. The value of a company is the PRICE times the MARKET CAPITALIZATION (number of outstanding shares). It is futile to compare the share price of two companies.
3. The investor’s valuation of a company is determined by the company’s earnings. However, they also use additional factors to predict a company’s market value. It is important to remember that the investors’ expectations and attitudes about a company that will ultimately determined the stock price.
4. Over the years, there have been many theories to explain why stock prices fluctuate. However, there is no one solid theory that can accurately explain how the market will move.