What causes Stock Prices to change?
Why do some stocks go up and others fall? In this post we discuss what causes this change in stock prices.
However, before we begin let us first get an understanding of how stocks are traded.
Stocks or shares are traded in a marketplace known as the Stock Exchange. Stock Exchanges are regulated entities which facilitate the buying and selling of shares.
Note that unlike other markets, in a stock exchange, there is no direct interaction between the buyer and seller. All buy and sell trades are placed and executed through the stock exchange.
The stock exchange acts as an interface between the buyer and the seller. The buyer and the seller never meet nor know whom they are buying or selling to.
Forces of Demand and Supply:
Price as we all know is an interaction of the forces of demand and supply. When demand increases with supply remaining constant, price increases. The reverse happens when demand falls with supply remaining constant. In such a case price falls.
How are Stock Prices Determined:
Stock price movements are also influenced by the same forces of demand and supply.
In the stock markets, stock prices are determined through a process known as bidding.
There are two type of bid a ‘buy’ bid and a ‘sell’ bid.
Note that bids have to be placed at particular price points. Thus a buy bid is a bid to buy a certain quantity of shares of a particular company at a defined price per share.
Similarly, a sell bid is a bid to sell a certain quantity of shares of a particular company at a defined price per share.
When the buy bid matches with the sell bid, the equilibrium price or the market price is determined and the trade gets executed.
Thus market price is the price point at which the buy bid matches the sell bid.
Note that bids may also be placed at the current market price which almost guarantees trade execution for a relatively liquid stock.
What Causes Stock Prices to Change?
We had earlier discussed that price in general changes when demand or supply changes.
Similar is the case for stocks.
Demand for a stock increases when investors anticipate a future rise in price of a particular stock. This could be caused by a number of factors like the prospect of an increase in the growth and profitability of the firm in the near future.
When investors are confident about the future prospects of the company and find the current stock price attractive, they place bids to acquire large quantities of the stock – leading to a higher demand for the stock.
The sellers too would be aware of the prospects of the company and may place higher bids sell. The buyers would then have to raise their bids in order to match the seller’s bids or to induce more investors to sell their stake in the company.
The trades thus gets executed at a higher price point and the market price of the stock moves up.
The reverse happens when investors anticipate a future fall in price for a particular stock. Again, this could be due to a number of factors like the entry of a potent competitor which could significantly reduce the margins of the existing firms.
When faced with such a situation, the sellers would rush to sell their stocks in order to preserve the value of their investments.
However, buyers may not be available at the bid/current price (which the buyers may find unattractive). They may place lower bids, and the sellers would have to bid lower in order to ensure that their trades gets executed.
As trades get executed at a lower price point, the market price of the stock falls.
This is what causes stock prices to move up or down.
Thanks for your time. Happy Investing.