The stock market may sometimes feel like a rollercoaster, with stock prices fluctuating every minute of every trading day. If we look at the price of a Tesla share back in January and February 2021, we can see that it peaked at $900 and then fell to $539 at the beginning of March. Now, in November 2021 it has reached new all-time highs at more than $1,000 a share. But why does that happen? What makes a stock price go up? At a high level, stock prices change because of buyers and sellers like you and me. We determine the prices of stocks by buying and selling positions at different price points.
To help you better understand why stock prices move up and down, here is a basic overview of some of the factors that set the prices of stocks.
- At a high level, stock prices are driven by supply and demand. When the buyers are in control, they push the prices up. Vice versa, when sellers are in control, they push the price down.
- Factors that impact supply and demand include current news, market sentiment, and investor and trader analysis.
Why Do Stock Prices Change?
To understand what drives the stock market, let’s make a quick comparison to restaurants. Michelin Star restaurants charge higher prices because of the expectations that people have when they dine there, whether that’s because of their reputation, quality of food, ambiance, or taste.
However, if a huge scandal happens or the quality of their food drops substantially, that may cause people to turn away from these establishments. Similarly, with the stock market, people’s expectations of stocks drive prices. If people feel that a stock will grow exponentially, they will pile their money into the stock. If people have strong convictions in a specific stock, they are willing to pay a high premium (Hint: Berkshire Hathaway Inc. Class A).
Supply and Demand
At the core of the stock market, prices are driven by supply and demand. When there are more buyers than sellers, that pushes the stock price up. When there are more sellers than buyers, that pushes the stock price down. If we look at the recent meme stocks saga, an army of individual investors on Reddit have taken on Wall Street by piling all their money into stocks such as AMC, Gamestop, and Koss in anticipation of their prices “going to the moon” or skyrocketing exponentially. As more buyers join in and continue to “hodl” (“hold on for dear life”), there will be fewer shares available for purchase, which drives the price up even more.
What Moves Buyers and Sellers?
Understanding supply and demand is simple enough, but understanding what buyers and sellers are thinking when they make decisions is much harder. Many factors will make people like or dislike a particular stock. While investors have different theories, let’s look at some of the factors that can affect supply and demand.
Current News and Market Sentiment
If people anticipate a major financial event in the near future, such as looming inflation or a rise in interest rates, that can cause fear and push people to liquidate all their positions. For example, recently, President Biden proposed a new capital gains tax plan that would tax all capital gains for people making over $1 million in income at 39.6% regardless of whether the gains were short-term or long-term. This could impact the stock market in the short term by causing affluent investors to liquidate their stocks early in anticipation of the tax hike or drive them to search for other strategies to lower their taxes. Economic, financial, or political news can lead to changes in people’s expectations, driving companies’ share prices up and down.
Market sentiment relates to the psychology behind investors and traders. If people believe a company’s shares are overvalued due to recent negative press or a change in expectations, they may start selling all their shares or shorting the stock even if nothing has fundamentally changed about the company. If a company reports positive earnings but anticipates that profits will fall in the next quarter, that can cause investors to panic and sell their shares, thus driving the price down. If a company has a compelling story that moves people to believe in its long-term growth potential, that can push the stock price up even if the company is highly unprofitable.
Reactions from current events and market sentiment could be emotional or a calculated decision, but they play a huge role in moving stock prices. If you get into the habit of keeping up with current news and gauging market sentiment, that could allow you to take advantage of the stock market.
Investor and Trader Analysis
Investors and traders rely on two schools of analysis to determine the value of a stock – fundamental analysis and technical analysis. Fundamental analysis focuses on evaluating a stock’s intrinsic value using data such as a company’s earnings reports, financial statements, company management, and economic and industry conditions. Technical analysis focuses on statistical trends, such as past price movement and trading volumes of stocks, and focuses on technical indicators, such as MACD, moving average crossovers, support and resistance, and VWAP.
For example, if an investor determines that a company’s price-to-earnings ratio (P/E ratio) is too high, they may start selling their shares. If a trader believes they have made enough profits from one of their positions, they may set take-profit orders at different price points to start exiting the position. Depending on the type of investor you are, understanding fundamental and/or technical analysis will help create a trading strategy that works for you.
As a long-term investor, I mostly use fundamental analysis to determine when to buy and sell stocks. However, I look at price patterns to buy stocks that I believe are undervalued at their current prices and regularly leverage the buy the dip strategy. While not recommended for everyone, I also set aside a small percentage of my portfolio to what I like to call “YOLO money” or fun money to purchase trending assets, such as AMC and Dogecoin, to ride the hype wave. However, in these instances, I think of these positions as gambling and take calculated risks based on how much I am willing to lose.
In simple terms, supply and demand cause stock prices to change. However, there are many factors that affect buyers and sellers, such as current events, market sentiment, and analysis. While this article does not cover everything, we went over a few common factors, which will hopefully guide you in the right direction on why it pays off to be an investor.