As the UK stockmarket reaches an all time high, it’s a timely opportunity to understand why stock prices rise.
There Are Three Things That Drive Stock Prices
1. Supply And Demand In The Market Determines Stock Prices
Market forces cause stock prices to change. It’s due to supply and demand. If more people want to buy a stock than sell it, the demand is high and the price will rise. But if more people want to sell a stock than buy it, there will be greater supply than demand and the price will fall. Supply and demand is an easy concept. What’s tricky to understand is why people like one particular stock over another. It usually boils down to what news is positive for a company and what isn’t. But if you ask ten investors for their opinion, you’ll probably get ten different ideas.
2. Comparing The Stock Price Of Two Companies Is Meaningless
The value of a company, or market capitalisation, is the price times the number of shares outstanding. The theory is that the price movement of a stock indicates what investors feel a company is worth. To further complicate things, the price of a stock doesn't only reflect a company's current value, it also reflects the growth that investors expect in the future. On that basis, it’s generally incorrect to equate a company’s value with its stock price.
3. A Primary Factor That Affects The Value Of A Company Is Its Earnings
Earnings are the profit a company makes. No company can survive without earnings. Analysts base their future value of a company on their earnings projection. If a company's results are better than expected, the price rises. If a company's results are worse than expected, the price falls. Unfortunately, it’s not just earnings that can change the sentiment towards a stock, which in turn changes its price. Investors have developed literally hundreds of variables, ratios and indicators to try and work out where the price is going next.
There Is No One Theory That Can Explain Everything About Stock Prices
The truth of the matter is that nobody really knows for sure why a stock price changes. Some people believe it isn't possible to predict how stock prices will change, while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell. The only thing you can say for certain is that stocks are volatile and they can change in price extremely rapidly.
Courtesy of Visual Capitalist.
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