The prices of stocks change frequently, one day they’re up, and the next day they’re down – much like a YoYo.
But understanding why they change so frequently is important to understand as you look to buy and sell shares and equity funds.
Just like any market supply and demand underpins pricing
The marketplace for shares is no different from any other. It is firmly underpinned by the concept of supply and demand.
The more demand there is for shares, the more their prices will increase. The increase can be amplified if there is less supply available. Likewise, if there is less demand for the shares, the price will be lower.
If supply and demand are about equal, you will not see much movement in the share price day-to-day until either the demand becomes greater than the supply (and you’ll see a rise) or the supply becomes greater than the demand (and you’ll see a fall).
When considering the demand for shares it is important to note there are two main distinctions between investors – retail investors (the likes of you and me) and institutional investors (these are big organisations investing lots of money on behalf of others including pension funds and insurance companies).
So by now, you are probably asking OK, so what affects the demand for a share? This is where we’ll look now.
Factors that affect Demand
Bull and bear markets – market sentiment and the feel-good factor
Sometimes investors are just feeling positive, high in confidence, and want to buy shares. This is generally known as a bull market (it’s when the market rises 20% higher than its previous low).
You’ll tend to see prices rise across the board and is not necessarily underpinned by a particular analysis. The opposite of this is a bear market where people feel less optimistic and demand comes down.
The economy and industry trends
When an economy is strong it is associated with high employment, healthy spending, and controlled inflation.
Businesses benefit from this. Therefore, share prices tend to rise as there is generally more certainty in the wider macro environment. People will be willing to make more risky investments and shares fall into that category.
Asset classes such as cash and bonds are viewed as less risky investments which is why in a economic downturn you tend to see demand for them increase and share prices fall – although not all shares fall equally or in some cases at all!
Some industries will benefit in some cases even in a poorly performing economy. Looking at the recent Pandemic, many healthcare and technology shares hit new all-time highs for example.
Company results – the earnings calendar and beating expectations
No one can predict the future, not even companies themselves, but they try. Companies will often issue regular guidance on where financially they expect to be in the future.
Quarterly updates are released to the market with fuller financials released during half-year results (interim) and ultimately the full-year results.
The full-year results are the moment of truth. Has the company performed as it and its investors expected? If so, you may actually not see much movement in the share price because the good news was ‘priced in’.
However, if the results are better than expected you will likely see a significant rise in share price. Likewise, if the results are worse, you will see a sizable fall.
Company results – the other side of the coin & missing expectations
When companies announce their updates and things aren’t what was expected then this can cause demand to fall and therefore the price of a share. In extreme cases, companies may announce profit warnings.
These are issued in advance of expected earnings or profit from a period to indicate they will be significantly below the previous expectations or guidance issued.
Broker views – meeting and surpassing their expectations
The previous sections have largely talked about expectations. But this is not just in relation to the guidance offered by the company, but more where the wider market expected it to be.
Brokers and investment analysts from big investment banks such as Goldman Sachs and UBS will ‘initiate coverage’ on shares.
This means a team of investment analysts will be analysing companies and passing on recommendations to their clients and the wider market. Like you, they will form a view or opinion on the company.
They will deploy more advanced analytical techniques than you or I, but crucially they get access to company management to get more of a picture of a company and forecast their future earnings or profits.
You will often see whether a broker has placed a rating on a share such as a buy, hold, or sell, and a target price of the share.
These should not be taken as an instruction for you to buy! If you can access the underlying commentary behind it, it can often give some good food for thought.
Analysts do get it wrong and have conflicting opinions on shares. This is part of what makes the market go round. Surpassing analyst expectations is often a key factor in a sudden share price rise following company updates.
Needless to say, if results miss expectations.
Factors that Affect Supply
Obviously, the selling of shares will affect their price of them as there will be an increase in supply if the total volume exceeds the demand to buy.
However, we’re going to look at two more examples that affect the supply of shares as controlled by a company and how they can impact the price:
- Share Buybacks: A company may buy back its own shares in its company. In doing so, it will limit the supply as it will usually be a big purchase. This can temporarily increase the price. The reason they do this could be seen as a sign of faith in the prospects or the pessimists would indicate it’s just a ploy to try and rescue the price of a share.
- Rights Issues: This is the opposite of the company buying existing shares in the market. A rights issue is seen as a negative – the company is tapping up investors for more money by issuing new shares. More shares flood the market and in turn, this drives down the price (temporarily at least).
Share prices are like YoYos, but look beyond the ups and downs
The price of shares will change day-to-day, sometimes you’ll be looking at +/- 0.5% other days +/- 5% or in some cases 20%+ following really positive results or news that the company is being acquired (and there’s a premium paid for this).
It’s important not to become too focused on the short-term day-to-day changes. As an investor, the challenge you have is to identify the long-term value of a share and have faith in your decision – that means riding out the lows and enjoying the highs.
There are a variety of techniques you can use as an investor to identify the long-term value of a share. This includes ratio analysis such as the P/E or PEG Ratio as well as more technical analysis on share price charts themselves.