Buying low and selling high is the deceptively simple formula for success in the stock market. Besides rising and making money for share owners, stock prices represent several things about a company and its investors. Reading too much into stock prices can be dangerous if you make assumptions that range beyond the scope of what a stock price actually stands for.
What Others Will Pay
Stock prices represent what other investors are willing to pay at the moment -- and which share owners are willing to accept -- for shares of a company. The share price at the end of the day, which is quoted until trading opens the next day, is just the price that was most recently paid for a share of the company before trading closed. Likewise, a daily, quarterly or annual high price simply represents the maximum that an investor was willing to pay within the given timeframe. Low prices reflect what share owners were willing to sell for. This is the only thing directly represented by stock prices.
Investors and economic analysts see stock prices as representing the financial health of a company. There is an indirect link between share price and financial health. This connection is indirect because buyers and sellers must first process information about the company before agreeing to new higher or lower sale prices. Annual reports, quarterly earnings, press releases, media reports and independent analyses all impact stock price by altering how well investors feel the company is performing or will perform in the future.
Rising and Falling
Changes in stock prices have their own signification. A falling share price represents a lack of confidence on the part of investors. Rising prices reveal that the stock is more attractive to investors, which may be due to issuing a dividend or announcing a new business model. Sudden changes in stock price may represent new legislation or regulation that will make it harder, or easier, for the company to profit. Rising stock price can also represent overall industry growth, especially if the price of shares of competitors rise at the same time.
Value and Opportunity
To a shrewd investor, certain stock prices may represent value and an opportunity for profit. Stocks with low price-to-earnings ratios are known as value stocks because of the favorable relationship between share price and the company's earnings. Stock prices that don't rise even as a company's prospects for growth improve represent opportunity for investors who can predict future growth. On the other hand, stock prices that are artificially inflated due to investors' emotions represent bad investments if the share price isn't indicative of sustainable financial success.
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