- There are multiple reasons for fluctuations in stock prices.
- Those reasons include fundamental factors, technical factors, supply and demand, and market sentiment.
Share price variation is a common phenomenon in stock markets and every one of us is aware of it. Stock prices rise and fall in value on a continuous basis. Novices often wonder why do stock prices fluctuate frequently? What are the main reasons for fluctuations in the market? These are some pertinent questions and we are going to give detailed answers to those questions in this post.
However, before delving deep into detailed answers, first, we need to understand how stock markets work. Stock markets are basically auction platforms where one party looks to sell its ownership of stocks in a particular company. On the other hand, another party looks to buy ownership in that particular company. When both parties agree on a price, the new price becomes the stock’s new market quotation. Trading volume, the number of trades of a company’s stock, indicates the interest of investors in a company’s stock. That’s how stock markets work and share price variation is the beauty of stock markets because that is what makes money for investors.
We know the fact that stock prices frequently fluctuate and share price variation actually makes money for investors. But, have you ever thought of how does share price increase or decrease? There are various factors that affect share price fluctuations but there isn’t a straightforward formula that tells us how. However, there are certain factors belonging to four categories that affect share prices.
- Supply and demand
- Technical factors
- Overall market sentiment
1. Fundamental Factors
Fundamental factors are the basic factors that affect share prices before other factors. These are the factors that determine the real value or fair market value of a stock. Fundamental factors can further be categorized into two, qualitative and quantitative factors.
Qualitative factors include all those factors that have nothing to do with numbers. They are related to the nature and standard of a company. These factors include;
- The business model – that explains what does the company actually does to make money.
- Competitive advantage – that illustrates whether the company has a competitive edge over its competitors or not. The competitive advantage gives companies an upper hand and ensures long-term growth and profits.
- Management – that has the quality and ability to execute the business model and business plan of a company. Impactful and quality management substantially increases the goodwill of a company and spreads positive sentiment among investors.
- Corporate governance – that indicates policies of the company regarding the role, responsibilities, and the nature of the relationship among management, higher hierarchy, and the stakeholders.
All these factors are used by investors to evaluate the stock of a company and they paint a better picture of the company’s financial performance and growth. Thus, these factors eventually affect share prices.
Quantitative factors deal with numbers and indicate the financial performance, stability, and growth potential of a company that ultimately affect share prices. Financial statements, consisting of the balance sheet, income statement, and cash flow statement, are the main sources for the stock analysis of a company. When investors analyze a company using those factors, they rely on them to calculate the bid price of a share. That is how these factors affect stock price variation.
2. Supply and demand
Shifts in supply and demand also cause share price variation just like supply and demand causes prices of other assets to go up or down. As a general rule, when more investors are looking to buy stocks of a company, the demand is high and so does the price. On the other hand, when investors are looking to sell and potential buyers are less, the supply is high, and as result share prices fall. However, supply and demand isn’t as simple a phenomenon as it seems. There are various supply and demand factors that we need to consider.
Supply factors affecting stock prices
A company’s stock issue, a company’s stock buyback, and a number of sellers are the key supply factors that affect stock price and creates variation. It is quite simple and natural as well that excessive supply of shares brings share prices down.
- When a company decides to issue more stocks to the public for purchase, supply increases. If the number of potential buyers is low, the stock price will fall as supply is greater than demand and vice versa.
- When a company decides to buy back its stocks, it results in fewer shares in circulation. It means the buyback of issued shares could increase the share price as supply is low. Buybacks also result in increased earnings per share that also has a positive effect on the share price.
- When more investors begin to sell shares, the supply increases. This normally happens as a profit-making scheme or when investors predict a reversal in share prices. If the demand doesn’t match the increased supply, the stock price will eventually fall and vice versa.
Demand factors affecting stock prices
Unexpected news about a company, unexpected events, and new trends in the industry is the demand factors that affect stock prices.
- Any expected or unexpected news about a company causes immediate share price fluctuations. For example, news about a company’s increased revenue and profits, new acquisition, new product launch, etc. positively affects share prices as good news increases demand. On the other hand, bad news such as missed sales targets, departure of key personnel in management or higher hierarchy, etc. lowers demand, and hence share price could fall. Even natural catastrophes cause a fall in share price as natural disasters disrupt business operations, reduce revenues and profits, and increase debts.
- New trends in the industry also affect the share prices of a company. For example, if an industry is booming, share prices of all companies in that industry could rise and vice versa. Moreover, the share price of a company also rises when its competitors are performing poorly.
3. Technical factors
Technical factors are among other key reasons for fluctuations in stock markets. These factors include inflation, interest rates, overall economic outlook, trends, liquidity, and demographic factors.
Inflation is one of the key reasons for share price variation. It means an unprecedented increase in the prices of goods and services over a particular period of time. It brings uncertainty for businesses as well as the general public. Inflation halts economic growth and also discourages investment including stock market investment. Even the best performers find themselves in an economic crisis as nobody wants to invest. The reason is increased inflation that negatively affects not only purchasing power of people but also investing power of investors. As a result that share prices begin to fall. The flip side of the coin is low inflation. It causes substantial economic growth and also encourages investment. As of result of low inflation, stock prices begin to rise as investors have more investing power.
The interest rate is a key factor in dynamics within an economy. Increased interest rates negatively affect share prices as high-interest rates make borrowing and debts really expensive for businesses. As a result, businesses have to face difficulties in operations, and profits and dividends also decrease significantly. Thus, share prices also begin to drop. Furthermore, increased interest rates significantly enhance the interest in fixed interest investments such as government bonds resulting in lower demand for stocks. Low demand causes a decline in share prices. Conversely, when interest rates are lower, businesses have to bear fewer interests on borrowed funds. Thus, positively affecting profit, dividends, and share prices.
The general economic outlook also affects share prices. The positive economic outlook increases the confidence of the public and investors. The economy begins to boom and expand. Businesses have more sales and offer new products and services. Thus, share prices rise because of growth in the economy and vice versa.
Current trends in the market about a particular stock also cause a substantial rise in that stock’s price. A growing interest in stock causes higher momentum and stock prices begin to rise. Conversely, the opposite trend causes a decline in stock prices.
Liquidity means the interest of investors in a particular company. All the popular companies are always on investors’ radar. Stocks of those companies always trade at high prices because of high liquidity. On the other hand, small-cap companies don’t have ready-made buyers and thus, their stock prices often don’t reach the highest levels.
Interestingly, demographics also play a part in share price variation. Studies have revealed that middle-aged investors remain in the game for the long term. Aged investors leave the stock market to manage retirement. So, a greater number of middle-aged investors increases demand, and thus share prices increase.
4. Overall market sentiment
Market sentiment defines the overall feelings of investors about a particular stock. Market sentiment is a key element in share price fluctuations because most investors rely on moods in the stock markets. They don’t rely on facts, figures, and concrete news. Sometimes, rumors about a company define the mood of the investors. That means market sentiment isn’t objective at all. It is totally subjective and often biased. However, it plays a key part in supply and demand. Thus has the potential to cause a rise or decline in share prices.
Share price variation means the changes in stock prices of a company. How does share price increase or decrease? There are multiple reasons for fluctuations in stock prices. Those reasons include fundamental factors, technical factors, supply and demand, and market sentiment. In a nutshell, the following are some key reasons that generate interest among investors about the stock of a company, and eventually the demand for stocks increases.
- Positive news about a company such as tax decrease in the relevant industry, company getting new contracts and tenders, and so on.
- Substantial growth in sales, revenue, profit, etc. indicates strong financial growth and stability of a company.
- Good news shared by a company’s management such as the purchase of new equipment and production plant, mergers, acquisition of a new subsidiary, and so on.
On the flip side, the following are some key reasons that play a part in decreasing positive sentiment about a company among investors, and eventually the demand for stocks declines.
- Negative news regarding a company such as management change, lack of tax compliance, and so on.
- A substantial decline in sales, revenues, and profits leading to the poor financial performance of a company.
- Significant increase in debts, account payables, and so on.