Although stock trades come from many different sources -- such as autonomous computer trading programs or program-trading orders set by investors -- all of them have a human being somewhere in the process, even if just to set in place the rules of the autonomous trading system. Over the course of the day, a stock's price usually fluctuates, whether in wide swings or narrow bands. Ultimately, all sources of trading and all fluctuations in the market over the short term are driven by one factor: human psychology.
Many hard facts influence stock prices. When a company releases an exciting new product, its stock usually goes up. On the other hand, when its board of directors gets enmeshed in an accounting scandal, its stock goes down. A quick glance at the financial news might make you think that news events are the primary causes of stock price movements.
Prices fluctuate because people, or the programmers of computers, think that a company's stock is now worth less and then worth more. News can cause fluctuations, but the price movements frequently exceed the change in a company's underlying value that the news indicates. If a company's quarterly earnings are a few percent lower than expectations, even if it's still on track to grow, it could lose 5 to 10 percent of its value in one day. Much of this swing is coming from the psychology of the traders in the market, overshadowing the impact of the actual news item. Other times, traders discount news, like when U.S. Treasury bonds didn't trade down after the government's debt rating was downgraded.
Sometimes prices bounce around certain numbers salient in investors' psychologies. When a stock goes from $9.99 to $10 or from $49.99 to $50, it takes on more significance than the dollars and cents of the move indicate. A $10 stock seems more expensive than a $9.99 stock, while an $11 share seems about the same as a $10 one. Surprisingly, many trading models use a variant of this concept by paying attention to these figures.
Technical traders buying and selling stock based on price or volume fluctuations may be the heaviest users of psychology in trading. They assume that they can predict what the market will do based on what it has already done. Concepts like momentum are based on market psychology, while the technical trading system being used is frequently chosen based on the trader's own psychological biases.
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