If you watch the financial news all day, you'll see that stock prices rise and fall frequently, every second in some cases. These stock price movements can often seem random. But beneath the minute-to-minute price changes, there are three main factors affecting the direction of stock prices. One is a technical factor, one is a microeconomic factor and the third is macroeconomic. The interplay of these three factors is the fundamental driver behind stock price movements.
Supply and Demand
There's an old adage in the stock market that stocks go up when "there are more buyers than sellers." It's a tongue-in-cheek comment, but the principle behind it is true. The single most important factor in moving a stock price is the supply and demand for the shares.
Stocks are bought and sold on an open market using a bid-ask system. The bid price is the highest price that buyers are willing to pay for a stock, and the ask price is the lowest price at which sellers will give up their shares. If there are a lot more buyers than sellers for a stock, those ask prices will be taken out, driving the share price higher.
Here's an example. Let's say Stock A has 100 shares available for sale at $50.25 per share. Another 100 shares are available at $50.26, and another 100 shares are available at $50.27. If someone comes in with a market order to buy 300 shares, that one trade would be executed at those three different prices. In one trade, the stock will rise from $50.25 per share to $50.27. In this simple example, that's not a huge jump, but it demonstrates how stock prices move up. If the buy order was for 10,000 shares instead, the stock would trade up until all 10,000 of those shares were filled, possibly pushing the stock up by 10 cents or more per share.
Supply and demand demonstrates how stock prices move up, but what creates the demand in the first place? An important factor is the financial performance of the underlying company.
When stocks earn more money, they become more valuable to investors. This is particularly true when a company earns significantly more than was expected by the investor and analyst community. For example, if a company is expected to earn 10 cents per share and they instead report a profit of 50 cents per share, the company will be much more in demand.
Other companies that are in demand are those that consistently report good earnings, in both good and bad economic cycles. These companies are more insulated to negative earnings surprises, and this stability often earns them a premium in the marketplace. Consistency and stability usually create a solid stream of buyers for a stock, keeping the price up.
Broad Economic Trends
The specific business trends that an individual company has to deal with form the microeconomic picture. But stocks are also affected by macroeconomic factors, such as the performance of the economy as a whole.
For most companies, no matter how well-run they are, it's harder to make money if the economy is going through a recession, defined as a period of economic regression. Thus, most companies show decreased growth rates during a difficult economy, and some even begin to lose money. In this type of environment, demand for stocks tends to dry up. When stock supply exceeds demand, prices go down, just as increasing demand drives share prices up.
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