Why do Stock Prices Fluctuate?
The history of the stock market is one of ups and downs. The high returns of the various East Indies companies were usually preceded or followed by failures and catastrophes. Before WW1, the US economy was at an all-time high level of optimism, continuing until the Great Depression of the 1920s. Similarly, the global economy boomed in the late 1990s and early 2000s as the technological sector underwent rapid expansion as part of the great dot.com bubble. That led to the down economy of 2004, the housing bubble of 2005-7 and the global recession of 2008. Currently, the onset of Covid-19 ended a 131-month long bull market period. This cyclical nature of the stock market makes it necessary for investors to understand how stock market fluctuations happen.
Factors responsible for stock price fluctuations
Stock market and trade are all digitised transactions conducted through the internet, with little to no human interaction. Then how do stock prices change during such transactions?
Several factors are responsible for share price increases or decreases. These can be divided into three subcategories: fundamental factors, technical factors, and market sentiments.
The fundamental factors which are responsible for price fluctuations include:
- The earning base level of a company's stock, which is expressed as EPS or other expressions such as dividends per share
- The earning base's expected growth levels: wherein a higher growth rate would result in higher stock multiples
- The discount rate, which is a calculation of inflation.
- The perceived risk of a particular company's stock at the time.
Technical factors refer to the external factors that influence price fluctuations by changing a company's stock's supply and demand equation. Such factors can also affect the essential factors indirectly. Technical factors which influence how stock prices change include:
- Inflation affects the prices of stocks inversely, with low inflation rates corresponding to a higher stock price. Deflation is a sign of the loss of pricing power of companies and corresponds to low stock prices.
- The strength of an economic sector and the market movement within determines stock prices to a large extent. If an industry is showing negative, then it is likely companies operating in that sector would have lower stock prices.
- Foreign exchange currency volatility affects share prices as the outcome of these determines the volume of international trade.
- Transactions conducted for hedging or taking advantage of insider trading affect the supply and demand chain and influence price fluctuations.
- Liquidity refers to the interest a company' stock garners from investors. The more interest is shown towards a particular block of stocks, the higher they are priced.
Alongside fundamental and technical factors, market sentiment can play a massive role in price fluctuations:
- Trends occur when a company's stock becomes successful for a while, thus garnering popularity from investors.
- Demographics also play a crucial role in price fluctuations, as middle-aged investors tend to be risk-averse or pull out of the stock market while younger traders conduct aggressive transactions.
- News plays a massive role in stock market price, as it influences the global economy by revealing various events which can affect trade-related sectors such as transport and health.
Understanding how and why share price fluctuates can help investors foster better investment practices and create opportunities for financial growth. Such an understanding can also help companies better manage their assets and provide the impetus for research and innovation to improve competitiveness.
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