Stock prices change every day due to market forces. By this we mean that stock prices change due to supply and demand. if more people want to buy a stock (demand) than sell it (supply), then the price goes up. conversely, if more people wanted to sell a stock than buy it, there would be more supply than demand and the price would fall.
Understanding supply and demand is easy. what is difficult to understand is what makes people like a particular action and dislike another action. this boils down to figuring out what news is positive for a company and what news is negative. There are many answers to this problem and almost any investor you ask has their own ideas and strategies.
That said, the leading theory is that a stock’s price movement indicates what investors believe the company is worth. Don’t equate a company’s value with its share price. The value of a company is its market capitalization, which is the share price multiplied by the number of shares outstanding. For example, a company that is trading at $100 per share and has 1,000,000 shares outstanding is worth less than a company that is trading at $50 but has 5,000,000 shares outstanding ($100 x 1,000,000 = $100,000,000 while $50 x 5,000,000 = $250,000,000). To further complicate matters, a share price not only reflects the current value of a company, it also reflects the growth that investors expect in the future.
The most important factor affecting a company’s value is its earnings. Profits are the profits a business makes, and in the long run, no business can survive without them. makes sense when you think about it. If a company never makes any money, it won’t stay in business. public companies must report their earnings four times a year (once every quarter). Wall Street is watching with rabid attention at these times, which are known as earnings seasons. The reason behind this is that analysts base their future value of a company on their earnings projection. if a company’s results are surprising (better than expected), the price goes up. if a company’s results disappoint (are worse than expected), the price will fall.
Of course, it’s not just earnings that can change sentiment towards a stock (which, in turn, changes its price). It would be a pretty simple world if this were the case! During the dot-com bubble, for example, dozens of Internet companies grew to market capitalizations of billions of dollars without ever making a single profit. As we all know, these valuations did not hold up, with most internet companies seeing their values drop to a fraction of their highs. Still, the fact that prices moved so much shows that there are factors other than current earnings influencing stocks. Investors have developed literally hundreds of these variables, ratios and indicators. you may have already heard of some, like the p/e ratio, while others are extremely complicated and obscure with names like chaikin oscillator or moving average convergence divergence (macd).
So why do stock prices change? the best answer is that nobody knows for sure. Some believe that it is not possible to predict how the stock price will change, while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell. the only thing we know for sure is that stocks are volatile and can change price extremely quickly.
the important things to understand about this topic are the following:
- At the most fundamental level, supply and demand in the market determine the share price.
- The price multiplied by the number of shares outstanding (market capitalization) is the value of a company. comparing just the stock price of two companies is meaningless.
- Theoretically, earnings are what affect investors’ valuation of a company, but there are other indicators investors use to predict the price of the shares. Remember, it is investors’ sentiments, attitudes, and expectations that ultimately affect stock prices.
- There are many theories that try to explain how stock prices move the way they do. Unfortunately, there is no theory that can explain everything.