Why Stock Prices go up and down

1. If you didn't know better, you might think the stock market had a mind of its own. Simply watch the stock prices for a week and there may be a chance that you'll see them drop or rise sometimes by dramatic amounts. Trying to make sense of those shifts might seem difficult, but closer examination would reveal that stock prices are shaped by concrete forces. Stock analysts, in fact, make their living charting these forces and their effects on companies, industries and national and international economies. An understanding of these forces can do more than help you formulate an investment strategy it will also help you see how events and trends can shape everything from the availability of goods and services to job opportunities.

Supply and demand

2. There's an old saying in Wall Street that a stock is worth what somebody is willing to pay for it. And that's true the price of a stock is determined by buyers. As they gain new information, investors decide whether they are willing to pay more for a stock or less. Their changing perceptions continually push stock prices up or down. Simply put, the price of a stock or for any product or service, for that matter is determined by supply and demand. The supply of stocks is based on the number of shares a company has issued, or sold to the public. The demand for stocks is created by people wanting to buy those shares from the people who already own them. If people think they will make money on a stock, they will want to buy it.

3. But here's the catch: supply is limited, and not everyone who wants to own a company's stock can. The more that people desire to own a stock, the more they will be willing to pay for it. High demand for a stock pushes up its price. Similarly, as the value of a stock increases, owners are more reluctant to sell it. The rise continues until prospective buyers decide the price has gone too high. Then, fewer people are willing to buy the stock at the high price. Stock owners who are anxious to sell must lower the price at which they are willing to sell. The stock's price falls until investors believe the stock is again worth the price at which owners are willing to sell.

4. The laws of supply and demand explain why stock prices fluctuate. But how do investors and analysts arrive at their decisions as to whether a stock is worth buying or selling at a given price? Above all, they examine the financial health of the company offering the stock. Investors are not likely to put a high value on stock in a company that's going to lose money. They look for a business with a history of making strong profits and consistently paying healthy dividends.

5. While history is important, investors also analyze a company's future prospects. A company with a poor profit history might have a promising future, and one with a good history might be on the way down. Therefore, careful investors also review how a company fares against its competition and whether it's being run by experienced, responsible people who keep up with current trends. If a company is viewed by potential investors as increasing efficiency or producing new, innovative products, its stock is likely to rise in price. Alternatively, trouble on the horizon damaging lawsuits, threats of a strike, more intense competition, or more stringent regulation can depress the value of a company's stock. When a major oil company announced that it was filing for bankruptcy, for instance, the value of its stock dropped 11 per cent.

6. A report that someone or some company is trying to buy a certain business usually pumps up that business' stock prices. That's because the purchaser has to buy a majority of the stock to gain control of the company. To do so, the suitor must persuade stockholders to sell their stock by offering an attractive price for their shares. Sentiment may also count. For example, when the owners of the Boston Celtics (USA) basketball team offered shares of stock in 1986, analysts suggested that the stock was overvalued. But investors most of them Celtic fans had a high regard for the team and were willing to pay the price to be associated with it. Another important factor to consider is the health of a company's whole industry.

7. A company's stock prices may go up or down depending on whether investors think its industry is about to expand (grow bigger) or contract (grow smaller). For example, a company may be doing well financially, but if its industry is declining, investors might question the company's ability to keep growing. In that case, the company's stock price may fall. Many industries expand and contract in cycles. For example, home building declines when interest rates rise.

Economic trends

8. In addition to events surrounding a specific industry or company, analysts carefully watch what they call economic indicators – general trends that signal changes in the economy. A key indicator is the change in the rate of economic growth as measured by the Gross National Product (GNP). GNP measures the total production of goods and services in our economy. If it is rising, then short-term business prospects are improving. Another important indicator is the inflation rate. Inflation occurs when prices are rising rapidly. During an inflationary period, a company's costs may rise faster than it can increase its prices; so its profits shrink.

9. Also, the inflation rate has a major influence on another key indicator, interest rates. Rising interest rates mean that the government, businesses and consumers must pay more to borrow money. As a result, the government's budget deficit increases, businesses may delay their plans for new projects, and consumers don't spend as much. That can set the stage for a recession a period of slow economic growth. Analysts also monitor the budget deficit – the gap between the money the government takes in and the money it spends. When the deficit grows, the government has to increase its borrowing of money that would otherwise be available to businesses to expand and consumers to spend.

10. Many other indicators signal changes in the economy. Among them are stock prices, unemployment rates (the percentage of workers who can't find jobs), and changes in the value of the currency of the country (the amount of foreign currencies that can be purchased for each ruble). These indicators are more than just numbers. They point to changes in the way ordinary people spend their money and, in turn, how the economy is likely to perform. If unemployment rates are falling, or if people are getting good values for their money, they are probably going to feel optimistic about the economy. They are more likely to spend money, benefiting companies and stock prices.

World and national events

11. Nothing alters people's attitudes toward saving and investing more than their perceptions of a major news event. For example, when a nation has declared war, stock prices may go up. That's because a country at war needs armaments, supplies for troops, spare parts, and huge amounts of fuel. So companies gear up to produce and sell more goods. News of other events can push stock prices down. If fighting between Iran and Iraq, for example, flares up in the Persian Gulf, U.S. stock prices may drop. That's because fighting may decrease the supply of oil coming from that region. As a result, oil may become more expensive and the cost of all U.S. goods that rely on oil or petroleum products may increase.

12. People are reluctant to invest unless they feel confident about the future of the economy. If investors aren't sure how a major event will affect the nation's economy, they're likely to hesitate about investing in securities. For example, if investors are uncertain of a new president's attitude toward business, stock prices may drop while investors await developments. You probably have heard the terms «bull market» or «bear market» many times without really thinking what they mean. A bull market is a period during which stock prices are generally rising. A bear market is a period during which stock prices are generally falling. Each of these is fueled by investors' perceptions of where the economy and the market are going.

13. If investors believe they are in the midst of a bull market, they will feel confident that prices are going up. Their own confidence helps to keep stock prices rising. During a bear market investors believe stock prices will fall. They hesitate to invest in stocks, and their own concerns help keep stock prices down. A bull or bear market can last anywhere from several months to several years. Many forces influence people's perceptions of the future and make stock prices go up and down. For the stock market to work well, investors must perceive that not only do they have a good chance of making money on their investments, but that all investors are treated equally.

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