Here’s What Causes a Stock’s Price to Go Up or Down — And How to Protect Yourself From Market Volatility

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From the time markets open until trading closes, stock prices fluctuate continuously.

Everything from a breakout news story to a shareholder meeting can affect a stock’s price. Often it has to do with supply and demand, as we saw during the infamous GameStop wave, when a collective of small individual traders drove up stock prices. While some lucky traders were able to sell the stock at its peak and profit, many traders hoping to make a quick buck instead lost money when the price eventually fell again

No one can predict every element that plays into stock price movements, although many try. That’s what the whole job of a hedge fund trader is all about: trying to pool money to maximize returns on investments, while predicting — or influencing, some say — what the market is doing.

The everyday investor will not spend all day watching charts go up and down. That’s why at NextAdvisor, we support a more passive approach to investing and encourage investors to buy and hold index funds, including mutual funds and ETFs, that include broad portfolios of securities spanning sectors and markets, rather than individual stocks.

One advantage of investing in index funds is that you can start building wealth even if you don’t have a lot of technical knowledge of the stock market. But for investors interested in adding individual stocks to their portfolio, it can be helpful to have a basic understanding of how to research stocks and track stock prices. That starts with paying attention to the news cycle, market conditions — and even your gut feeling.

Here’s what you need to know.

What factors move stock prices?

Almost all daily events can affect stock prices. After all, the market is a reflection of how companies and industries are valued in our society. Because we are the fickle creatures that we are as humans, our ideas of value are constantly changing.

Pro tip

Investing always involves a certain amount of risk. That’s why it’s a good idea to spread your investments across many different stocks.

Everything from a public relations crisis to the latest company news can affect a stock’s price. If investors, especially at the hedge fund level, feel any cause for concern, we may see that drama unfold in the stock market. The same is happening with factors such as the Federal Reserve’s interest rate policy, geopolitical events such as wars and boycotts, and even factors such as innovation and technology, such as the hype we are seeing around cryptocurrency right now.

“Many of these factors can be attributed to ‘noise’ and increase daily price volatility,” says Jim Plumbvice president and senior analyst at the Illinois consulting firm RMB Capital.

But one factor affects stock prices more than any other: profit.

“In the long run, stock prices converge to the present value of future cash flows generated by the underlying company. Ultimately, these fundamentals will have the biggest impact on stock prices,” Plumb says.

Further on, we explain how the many factors work together to influence stock prices.

Fundamental Factors

The two most fundamental factors come down to profitability and the valuation ratio, says Juan Pablo VillamarinCFA and senior investment analyst at Intercontinental Wealth Advisors.

“Profit is the ultimate result of many sub-factors: revenue potential, management competence (such as governance, skills), and cost management,” Villamarin says. “Although somewhat more abstract, the valuation ratio is the relationship between a particular financial measure (such as income, income, cash flows) and the market value of the entity.”

The most well-known measure is the price-earnings ratio — or P/E — ratio. AP/E ratio is the ratio between a company’s stock price and earnings per share. Investors use these ratios to compare the performance of comparable companies to the records of one company, both historical and projected earnings.

Technical factors

Technical factors are things that change the supply and demand of stocks, but don’t fundamentally change the prospects for cash generation, Plumb says.

“Take a stock split, for example,” he says. “If company XYZ were trading at $100 per share with a total enterprise value of $100 million and offering a 2-1 stock split, the shares would now be trading at $50, but the total enterprise value would not change as there are now two times as many shares are available,” he explains.

Although it’s a stock split, Plumb says some investors are being tempted by the discounted price, even though company fundamentals haven’t changed.

Technical factors can also include the time or specific days of the week when a trade occurs compared to other days and times, Villamarin says. In addition, the price movement of a stock compared to the movement of another stock in the same industry or business sector can also affect the stock price.

“These technical factors can be important because they provide insight into the supply and demand dynamics of the inventory,” Villamarin says. “Some factors can reflect and predict future demand for a stock,” he says.

Trends – both historically of the company and of an industry as a whole – are considered technical factors.

News

If you’ve ever seen a company’s stock price rise or fall after an earnings call, it’s because of the news.

“The trick is to decipher news that can affect fundamentals, rather than noise that can alter a stock’s supply and demand in the short term,” Plumb says. “News that alter the likelihood that a company will be able to generate cash flows in the future can have a major impact on prices, especially if the impact is significantly different from current expectations.”

Quarterly results can cause the stock market to fall as well as rise, although the effects are not always straightforward due to the myriad of factors involved in determining stock prices. For example, in January 2021 Apple shares fell in price despite the company reporting record quarterly profits.

Things that happen in the world in general can also affect stock prices. Amid the COVID-19 pandemic, the stock market as a whole has had some major declines† The first was in March 2020 and the most recent was this summer when the Delta variant popped up across the country, raising concerns about market recovery.

Market sentiment

Market sentiment, or investor sentiment, is the investor’s outlook regarding the performance of a particular stock in the market. Sentiment drives demand, which also influences supply.

“It is used to describe market expectations regarding parts of financial market statistics,” Villamarin says. “Market sentiment is key because at the end of the day, supply and demand forces are critical to the movement of asset prices over the medium term. Psychology is critical to market dynamics.”

There are several theories that attempt to explain how market sentiment can drive supply and demand for stocks:

The behavioral financial theory: This theory looks at psychological factors when analyzing financial markets. Some investors trade based on emotion and, in some cases, over-confidence in a particular security or asset. These reactions can lead to biased investment decisions, potentially damaging your investment.

The Animal Mind Theory: This theory assumes that humans act instinctively in uncertain situations, in the same way that animals would. In turn, actions – such as making moves in the stock market – are also driven by instinct. If the market is good, investors will buy. If the market is bad, investors will sell. Even if the instinct is not necessarily right, it is a driving force in decision-making.

“In periods of greed, market participants believe that stock prices will continue to rise and are willing to pay increasingly higher prices for stocks,” Plumb says. “Greed eventually turns to fear as investors begin to realize expectations have gotten too high and stocks begin to sell,” he adds.

Plumb says we can measure market sentiment using the CBOE Volatility Index (VIX), or the “fear index.” The higher the VIX goes, the greater the fear among traders. The lower the VIX, the smaller the fear. When the market is stressed, VIX goes up. The VIX averaged 15.4 in 2019, but reached a near-record high of 82.69 at the start of the COVID-19 pandemic in March 2020, according to Reuters

Bottom Line

While using your instincts and intuition when investing, it’s easy to let your emotions get the better of you. Keep in mind that even with careful research, investing always carries an inherent risk. It is a good idea to diversify your portfolio as much as possible so that you spread your risk across multiple investments. An easy way to do this is to invest primarily in ETFs and index funds rather than individual stocks.

Index funds and ETFs are great ways to build wealth with relatively little maintenance and low barriers to entry. If you also want to invest in individual stocks, it’s always a good idea to do your research and get informed about a stock’s past and potential performance before buying.

Ultimately, while the stock market can have its ups and downs in the short term, investing is a great way to build wealth in the long run. Make sure you invest smartly with a strategy that fits your financial goals, and keep your focus on your long-term goals (such as saving for retirement) to avoid making hasty decisions based on short-term panic or fear of losing money. miss out.

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