Sunday, August 17, 2014

What causes stock prices to change?

I remember a good friend coming to me one day all excited because according to him, one of the banks he owns shares in had announced that they had added 3 new branches to their growing branch network. He was excited because according to him, this means the price of the shares is about to increase and he will profit from it.

While my friend may not be totally off the mark in his believe, this is one area which most people find confusing. I keep getting asked this question: “what makes stock prices to increase or decrease?”

To be sincere, the answer to this question can be as simple or complicated as you want it to be. The simple answer to that question is this – “Demand and Supply”. If the demand for a particular stock (i.e. the volume investors are willing and able to buy) is higher than its supply (i.e. the volume investors are willing and able to sell), the price of that stock will increase, all other things being equal. That is what accounts for price changes in a stock.
A more detailed answer to the question can however come in this form. Prices change due to:


1.       Activities of institutional investors: Institutional investors (i.e. companies such as banks and mutual fund companies which invest in other companies) are usually responsible for changes in the price of stock. This happens because they normally transact business (i.e. either buy or sell) in large volumes, leading to the exertion of significant pressure on the share prices. For example, if a mutual fund company owns the majority shares of another company and decides to offload or sell all of those shares on the open market, there is a great likelihood of the price of those shares coming down. The reverse of this is equally true. Individuals who own large chunks of shares in a particular company also have the ability to cause price movements.

2.      Dividends or Earnings of the stock: Another factor which usually elicits enough price response from the market is Dividend or Earnings announcements. This is especially true of companies who are perceived as “dividend paying companies”.

3.      Market expectation: Generally, the expectations of market participants also cause price movements. An example of this is the story of my friend which I started the post with. So for example, if a large number of people believe that the price of that stock is going to increase as a result of the branch expansion, it is very likely to result in an increase in the price of that particular stock. This is because those people will increase their demand for that share.

Finally, I want to say that ultimately, it is investors’ sentiments and expectations which carry the greatest weight. That is what actually drives the market.

Author: M.D. Avor

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