Hey, it’s Baku. In this blog, we’ll be talking about reasons why stock prices go down and why they go up. More importantly, we’ll be talking about how you, as a stock market investor, can use this knowledge for your benefit.
When I talk to people who are not stock market investors (and also to new stock market investors), they always seem to think that stock price movements are a thing of complete mystery. But technically, most of the time, there are obvious reasons why stock prices move up and down.
Later on, we’ll also talk about how you can make use of stock price movements to make better investing decisions when it comes to when to sell or buy a stock.
Let’s Get “Supply And Demand” Out Of The Way
I see this in Facebook groups all the time. Beginners asks “Why do stock prices go up or down?” and someone just comments “demand and supply” without any other explanation as to what that is or any mention of anything else helpful for the beginner who asked.
In a way, the answer “supply and demand” is correct. That is partly a fundamental reason why stock prices change.
However, a more correct answer would be a list of underlying reasons as to why the supply and demand of a stock changes, which is what we’ll talk about in this blog.
Before that though, let’s just quickly go through what supply and demand really is.
Basics of Supply and Demand
Supply is really just the number of stocks that are for sale by the sellers. And demand is the number of stocks buyers want to purchase. Easy right? But how do they interact with each other? And how do they affect price?
Well, if there are way more supply than demand, then the sellers will find it difficult to sell their stock. This usually forces them to sell at lower prices. The more the seller want to sell their stock, the more supply there will be, and the price will go lower and lower as the sellers’ race to undersell everyone else.
The opposite is true if the demand is way higher than the supply. When there is a lot of demand by the buyers interested in a stock, the sellers can easily sell their stock to the eager buyers. If you are the stock seller in this case, what would you do? Well, increase the price, of course! They are interested, so why not increase the price? High demand means the buyers will keep buying the stock, and the sellers will keep increasing the price as they sell.
So, in short, if there are more supply than demand, the price will eventually decrease. But if there are more demand than supply, the price will increase.
How Does Knowing About Supply and Demand Help You?
Well, learning about demand and supply is one of those things that are mostly just good to know about. But when it comes to making you a much better investor, it doesn’t really help much.
The more important lesson is really on learning about why investors choose to sell their stocks (which increases supply) or why investors would choose to buy more stocks (which increases demand). This is what we’ll talk about below!
Aspects That Affect Stock Prices
Company Specific Events and News
This is the first and also very obvious thing that changes stock prices.
Bad things that happen to the company will decrease the price as some investors will dislike the stock and sell their shares for lower prices. News directly affecting the company like “ABC Inc., Revenues Decrease by 50%” or “XYZ Airlines Losses Lawsuit Against Competitor” will surely drop the stock price.
Good news about the company, of course, has the effect of increasing the stock price. This is because investors will want to acquire the stock of a good business, even when sellers are selling it for higher and higher prices.
News like “ABC, Inc. Expenses Lower Than Expected Resulting To High Profits” or “XYZ, Inc. To Acquire Another Good Performing Company”, and the like, usually has the effect of increasing stock prices.
Industry and Economic Events
There could also be some good or bad news from certain industries or the overall economy that could affect stock prices.
News like “Inflation Rises To 7%” or “Unemployment Rate Now Higher At 11%” or “GDP growth drop down to 4%” will usually decrease the stock prices of most stocks.
Good news like higher GDP rates, lower unemployment, manageable inflation and the like will increase stock prices.
Some of you are probably thinking: “Hey, these news don’t necessarily affect all companies!”. And yes, even though a company isn’t directly affected by this news, investors sometimes overreact and start selling or buying stocks.
General Investor Perception
I’ve heard of some investors say that they sold a stock just because they don’t believe in it anymore. Sometimes they have a good reason why, and sometimes they don’t.
Some investors even sell their stock, and their reasons is that they “heard from someone” that the stock is no good. Or the opposite where they buy a stock because they say “someone told me it’s a good buy”. These are seriously not great reasons to buy or sell a stock.
In any case though, when investors or a group of investors believe in a stock, they will start buying it and the price will increase.
And the opposite can also happen where, with or without good reason, investors might suddenly like a stock, so the stock price will increase.
One example here is when I see investors buy/sell a stock just because they hear their friend or family (or sometimes even an internet stranger) is buying/selling the stock too. This is, of course, not a logical move, but some people do it and it does affect stock prices.
Are Stock Prices Always Correct?
Now you know why stock prices increase, for the most part, and why they decrease.
But there is one fundamental thing you should know: stock price movement are not always correct. (Or we should also say that other investors are not always correct.)
What does that mean? Well, just because investors are buying the stock which increases the demand and also increases the stock price, doesn’t mean that the stock price should have increased in the first place.
For example, TSLA (Tesla Inc.) was priced at around $100 per share sometime in 2019. When 2020 came, there were a couple of really good news about TSLA that sparked interest in investors and so they bought the stock.
With the rising demand, the stock price kept rising higher and higher and higher. At the time of writing, TSLA is very close to $700 per share! But if you ask me, and some other financial analyst, TSLA probably should not be priced at $700. That’s too much, most likely.
Basically, even though investors that are buying and selling TSLA are pricing the stock around $700, that doesn’t mean that it is the proper price of the stock. Again, I would say TSLA is currently overpriced and you should probably not purchase any more as it is too expensive. (And it is probably the best time to sell the stock!)
The opposite can also happen where investors sell a stock, but too many are selling and so the stock price will decrease. If it decreases too much, then it can be undervalued (or discounted). This would actually be the right time to buy that stock! (Well, as long as it is from a good business.)
Significant key points
- Stock prices increase when there is a lot of demand (or there are many investors that want to buy the stock)
- Stock prices decrease when there is a lot of supply (or there are many investors that want to sell the stock)
- Investors will want to buy or sell a stock because of news and events that specifically relate to the company, or the industry or country of the business
- Sometimes though, investors buy or sell the stock for no good reason or because they “heard from someone that they should buy/sell the stock”
- Stock prices are not always correct, as sometimes overselling or overbuying causes the stock to be under-priced or overpriced
- It is best to buy a stock when it is under-priced (as long as the business behind the stock is performing well), and it is best to sell the stock when it is overpriced
Well, there you have it.
Now you don’t have to wonder why a stock price is rising or falling.
Not only that, but you also know that when stock prices are falling, it is the best time to buy it. And when the stock price is rising, that is when you sell. The basic Buy Low, Sell High (which is easier said than done, unfortunately!)
Comment your questions below. Good luck and we hope you learned something!
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