The stock market works as a double-auction market, where the basic forces of supply and demand are in full vigor. A buyer and a seller meet, usually electronically, and haggle over the price of a particular stock. If they can agree on a price, the trade is made. The core factor that determines the market price of any share of stock is how much someone is willing to pay for it.
Supply and Demand
The concept of supply and demand works the same in the stock market as it does in any other trade scenario. If you have more product than you have buyers, the market price of the product tends to drop. If there are more buyers who want a product than there is product to go around, the market price of the product tends to rise. While supply and demand is the bottom-line factor that determines a stock's market price, there are lots of things that influence supply and demand.
Stock represents ownership in a company, and each share of stock represents an equal amount of that ownership, which includes the company's assets. If a company has substantial holdings, such as real estate, equipment, investments in other companies or money in the bank, those assets provide a financial base for stockholders. In a worst-case scenario, if the company's assets were liquidated and all debts paid, whatever was left would be divided by the holders of common stock. Even if there is little demand for that company's stock, the market price of its stock is supported at that level by its shareholder equity.
A well-managed company that produces profits on a regular basis is typically more attractive to investors than a poorly managed company that breaks even, occasionally produces a profit or consistently loses money. The more attractive a company is in the eyes of investors, the greater the demand for its stock becomes and consequently the higher the market price of that stock rises. On the flip side, if investors are consistently disappointed with a company's financial performance, they will typically sell their stock in the company, creating a glut in the market that tends to drive the stock's price down.
In many cases perception trumps reality when it comes to stock prices. Positive or negative news about the company, the stock market, the industry sector, the economy as a whole or international events can create a positive or negative perception in the minds of investors. Those perceptions, whether or not they are true, can cause investors to buy or sell a particular stock, creating a supply and demand imbalance, which in turn drives the market price of a stock up or down.
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.