Stock values fluctuate a lot, rising and falling in value (sometimes dramatically) within a single trading day. Novice investors may be perplexed as to why this is so.
Here is a quick explanation of some of the forces that produce this volatility to help you understand. Continue reading to learn how the stock market works and how stock values are determined.
Important Points to Remember
- The stock market is effectively an auction where buyers and sellers haggle over the price of publicly listed company shares.
- Individuals, governments, corporations, organizations, and asset management firms can all trade on the stock market.
- The key factor determining the price of stocks, like any other market, is supply and demand.
- Other causes that might generate substantial price variations include important financial news, natural disasters, investor reaction to business financials, and pricing speculation.
Why Do Stock Prices Fluctuate?
The Stock Market Is a Bidding War
The stock market is essentially an auction, with one party wishing to sell their ownership in a firm and another wanting to buy it. The trade is matched when the two parties agree on a price, and the new market quotation for the stock is established.
Individuals, firms, institutions, governments, and asset management companies that handle money for private clients, mutual funds, index funds, or pension plans can be buyers and sellers. You may not know who is on the opposite side of the trade in many circumstances.
The “trading volume” refers to the number of shares exchanged, and it can reflect how “hot” a stock is or how much interest it has from other investors. It can also show traders how easy it will be to enter or exit a position in a certain stock.
Demand and Supply
Supply and demand have an impact on stock prices. Because the stock market works like an auction, when there are more buyers than sellers, the price must adjust or no trades will take place. This circumstance tends to push the price higher, increasing the market quotation at which investors may sell their shares and persuading investors to sell when they were previously hesitant to do so.
When sellers outnumber buyers and demand is low, the price is established by whoever is ready to take the lowest bid, resulting in a race to the bottom.
It can be an issue when big amounts of stock are dumped on the market all at once. For example, during the financial crisis of 2007–2009, companies like Lehman Brothers were compelled to sell everything they owned in order to earn cash while they battled bankruptcy, as many of their assets were illiquid.
This practice inundated the market with securities worth far more to a long-term buyer than Lehman was ready to sell them for.
What Factors Affect Buyers and Sellers?
The value of company shares does not fluctuate considerably on a typical day. Prices frequently fluctuate by a percentage point or two, with bigger swings on rare occasions. However, circumstances might arise that cause shares to quickly surge or fall.
External Circumstances
An earnings report that contains positive or bad financial news could lead to increased trading. It could be a huge financial news event, such as an interest rate hike, or a natural calamity, such as a storm, which has the potential to have far-reaching implications. Any of these occurrences could cause a market reaction, prompting investors to sell or buy. These reactions could be based on emotion or be the product of a deliberate decision; either way, they have the potential to alter the stock’s price.
Investor Evaluation
The way you invest can have a big impact on how much stock you sell. Consider the case of a corporation that releases a disappointing earnings report. As supply surpasses demand, some shareholders in that company’s stock may panic and sell their shares, sending the price down. Some investors, on the other hand, may view the negative news as transient and perceive an opportunity to buy shares at a bargain until the stock’s value improves again.
Speculators—those who buy and sell stocks based on some criterion other than the company’s fundamental value—can drive stock prices to extremes. Compare them to investors, who are solely interested in buying stock at a lower price than it is worth, with the expectation that it would increase in value over time.
Investors who utilize the value investing strategy typically buy or sell shares based on their assessment of a company’s balance sheet and overall perception of whether it is fairly priced.
Frequently Asked Questions (FAQs)
How frequently do stock prices fluctuate?
Many people refer to the price of a stock as the price of the most recent transaction. As a result, anytime a new transaction occurs, the price changes, unless the new transaction is for the same price as the prior one. Every day, major stocks such as Apple trade millions of times, and the stock price might shift as a result of each transaction. Penny stocks that are thinly traded may only trade a few thousand times each day, implying that the price changes less frequently.
Why do stock prices differ from broker to broker?
In theory, regardless of the brokerage, you should pay the same amount for a stock. In fact, minor differences in features like execution timing or charge structure may result in minor pricing differences. The more liquid a security is, the less chance there is for minor variations to effect its price. If you’re concerned about price disparities, a limit order that ensures a price is the best option.
