Table of Contents
Chapter 1: Introduction to Trading Stocks
Chapter 2: Different Categories of Stocks
Chapter 3: Functioning of The Stock Market
Chapter 4: Stock Market and Price Movements
Chapter 5: How to Buy Stocks
Chapter 6: Choosing Your Investment Strategy
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Chapter 4: Stock Price Movements
– Demand and Supply Balance
– Factors Affecting the Demand and Supply Balance
– Bull and Bear Markets
Chapter 4: Stock Price Movements
In order to understand the price movements of stocks, it is important to comprehend a basic economic concept – demand and supply. It applies to all transactions we see in our everyday life but it is more evident in situations where the two opposing forces cause significant price fluctuation.
Consider a hypothetical scenario where 5000 shares of Company A are available for sale in the market at a price of $50 per share. There are 2000 buyers who are already in the market looking to buy one share each at this price. That leaves 3000 shares unsold. After a while, the sellers realize that all the existing demand for shares at $50 has been used up so they attempt to make these shares more attractive by bringing the price down to $45.
The lack of demand or excessive supply has affected the price of the share. In a demand intensive and short supply scenario, the tables are turned and it is a seller’s market. The seller can hike prices and still find buyers.
In the share market, the supply demand functions are not as simplistic as the example but the basics are the same. When demand is less than supply, the price falls, and when demand is more than supply, the prices goes up.
Factors Affecting the Demand and Supply Balance
Demand and supply are simply expressions of market sentiments. These market sentiments are, in turn, an expression of what investors think about the prospects of a company. If the general feeling about a company is positive, more people want to own its stocks, boosting demand. Bad news about a company makes people less interested in its stocks, causing a drop in demand.
Factors that can affect the stock price of a company:
a. When a company declares its financial results, investors revisit their assessment of the company. If the results are better than expected, both demand and price for that stock typically go up.
b. Announcement of new projects or orders or any other positive news from the company can push the stock price up. These positive events are expected to increase the company’s profits and this greater profit potential gets reflected in the share price. This is the reason why information about such events is so closely guarded so that no one can make undue profit from these announcements at the expense of other investors.
c. A change in top management often causes many investors to put transacting in that company’s shares on hold. The uncertainty of how the firm will fare under new leadership prevents investors from buying. On the contrary, if a dynamic new CEO with a great track record is taking over the reigns at a company, then new investors may flock to buy its shares.
d. Economic conditions play a big role in determining trading activity. Although trading is subdued on the whole during recession, there may be companies providing essential products or services like medical services, and they may continue to do well. The need for such products and services is always present and investors prefer to invest in these almost certain winners in uncertain times.
e. Some companies may have political affiliations. When the country’s leadership changes, the fortunes of these companies may also be affected. If there is an election coming up where no clear indications are there of the outcome then such companies may lose favor until the elections clear the uncertainty.
f. Similarly, the performance of many industries depends on the varying attitudes of different political parties. Depending on which party is in power, the overall industry may or may not flourish, taking the companies in that sector with it. Infrastructure is a sector whose growth significantly depends on the views of a country’s leaders.
g. Personal preferences, media hype, publicity – both negative and positive, and many other factors affect demand and supply in the stock market. These factors in conjunction with the company’s profitability track record determine when investors buy, sell or hold its shares.
The terms bull market and bear market are often used to describe certain phases in the stock market. These refer to the trend that the market displays at a given period and also the risk appetite of an investor.
The term ‘bear’ market comes from the fact that bears tend to press their victims down. When stock prices are subdued and there are predictions of a further drop in prices, the market is said to a ‘bearish’ one. The downturn in prices may last for months or even years. Most experts believe that a bear market is an inevitable phenomenon which usually occurs every 4-5 years in the stock market.
In a bear market, there are more sellers than buyers. This demand supply mismatch keeps prices low while pessimistic market sentiments prevent buyers from exposing themselves too much through purchases. In general, the market is said to be ‘bearish’ if the price levels are down by 20% or more from the last high.
An investor who expects that prices will fall is a ‘bear’ investor. His belief influences his investment pattern. A bear investor hesitates to make large investments unless he feels the bearish trend is drawing to a close. At this point he picks up stocks at low prices, hoping to sell them when the bullish trend sets in. The typical bear investor parks his funds in highly conservative investments.
The bull market is the complete antithesis of the bear market and generally starts when a bearish phase ends. Prices are at peak levels in bull markets and still soaring upward with no end in sight. The market is abuzz with buying activity as demand reaches new highs. The increasing demand in face of limited supply takes stock prices higher. A number of new companies enter the stock market in a bull phase to raise the maximum capital from their IPO. A 20% rise from recent lows can be seen as an indicator of a bull market.
An investor who believes that stock prices will continue to rise is a bull investor. He tends to hold on to investments or invests more in a bid to maximize profits by selling at an even higher price some time in near future when the market peaks.
The danger with this kind of investing is that the point at which you buy may well be the peak and the markets may begin to tumble from then on. This leaves you with a stock which is valued at a much lower price now than what you paid for it. The uncertainty in the market makes it impossible to predict or assess when peak prices have been reached and when the downward spiral will begin.
Next Chapter: How to Buy Stocks
