5 Reason Stocks Drop and Rise So Much
The stock market works as a double auction market. Buyers offer a price they are willing to pay for a particular stock, while sellers offer stock for sale at a price they are willing to take. When the bid price and the ask price match, a stock trade is made. While many factors can influence a rise or fall in a stock's market price, ultimately it all comes down to how much someone is willing to pay.
One of the most fundamental driving forces for changes in a stock's market price is the company's financial well-being. This includes such factors as earnings per share, sales, market share, research and development, management experience and innovation. The stock of a company with a long history of profitable operations is more likely to perform well in the open market than the stock of a company with poor earnings.
Perception sometimes trumps reality when it comes to determining a stock's market price. The stock of even well-managed, profitable companies can take a tumble if their perceived value does not equal their actual value. For example, if stock analysts project quarterly earnings of $2.75 per share, but a company only delivers $2.25 per share, the stock price might fall, based on the perception that the company did not perform well.
A company's stock price can be affected by trends within the company's industry. If investors expect an entire industry to expand rapidly, they are more likely to bid up the price of stocks of companies within the industry. Conversely, if investors see a downward trend in an industry, they might try to sell their stocks in companies in that industry, which tends to drive stock prices down.
Inertia is one of the primary laws of physics: An object in motion tends to remain in motion unless acted on by an outside force. The same is true of stock prices. Regardless of fundamental factors, such as earnings and management, once a stock starts moving either up or down, the tendency is for investors to jump on the bandwagon and drive price movement faster and farther, until the bubble bursts and a correction takes place.
News of national or international events can have a dramatic effect on stock prices. For example, the Dow Jones Industrial Average plummeted 684 points after the attacks on Sept. 11, 2001. News of falling unemployment rates can cause stock prices as a whole to rise, while news of impending wars, embargoes or boycotts might hold stock prices down. Even amid good or bad news, individual stock prices can perform opposite of industry trends.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.