Why Does the Stock Market Fluctuate?

The stock market is not a single entity, but rather a reference to every stock of every company, public or private, whether listed on a stock exchange or traded over-the-counter. It includes companies from around the corner, and in our global economy, from around the world. The stock market fluctuates because the individual stocks that make up the stock market fluctuate. Individual stocks fluctuate based on supply and demand, but there are a multitude of factors that influence supply and demand.

Market Indexes

When your local newscaster reports, "the stock market is up" or "stocks took a beating on Wall Street," he is typically not reporting on the status of the entire stock market. He is usually reporting on the status of a market index, such as the Dow Jones Industrial Average or the Standard and Poor's 500. These indexes use a representative group of stocks as indicative of a particular sector of the stock market.

Earnings and Profitability

One of the fundamental factors that influences stock market fluctuation is the general financial health of the companies that make up the stock market. According to the Federal Reserve Bank of San Francisco, two firm-level stock indicators that influence movements in the stock market are earnings per share and the price-earnings ratio. Earnings per share refers to total amount earned divided by the total number of outstanding shares of common stock. The price-earnings ratio, commonly referred to as the PE ratio, refers to a stock's market price compared to its earnings per share. Rising earnings per share rise and expanding PE ratios typically result in increased stock prices, which cause the stock market as a whole to fluctuate upward.

News

The stock market tends to be an emotional marketplace that is easily influenced by news. The stock market reacts whether the news is good or bad. The market reacts to news that is directly related to the financial markets, such as an announcement by the Federal Reserve of higher interest rates, but it also reacts to news that indirectly affects financial markets, such as news of an impending war, political elections, consumer fears or just about anything else that affects a lot of people.

Bull and Bear Markets

When the value of a particular indicator, such as the Dow Jones Industrial Average or the Wilshire 3000, trends upward for a sustained period of time resulting in gains of approximately 20 percent, the stock market is said to be in a bull market. When the value of the indicator trends downward, the market is said to be in a bear market. Factors that contribute to such sustained stock market fluctuations include a combination of supply and demand for securities, government intervention, investor psychology and changes in economic activity.