Why do stock prices change so much? If this answer was simple everybody could have timed the market to perfection.
Mr. Market causes price to change erratically.
There are several reason which causes price to fluctuate like this.
In this article we will see why stocks prices fluctuate like a boat in rough sea.
Demand and supply imbalance of stocks cause stock prices to move up and down.
The logic is simple.
When investors are buying more stocks (high demand) its price will go up.
When investors are selling more stocks (high supply) its price will fall.
The same logic applies for any item in the market. But stocks are special, why?
It is difficult to find a valid reason why people are buying or selling a stock.
This happens because market is heavily driven by emotions than by logic.
When emotions rules, we can find less valid reasons that will explain why stock price change so much.
Logical investing in stock market will ensure predictability of market.
Mr. Market is clever…
But Mr. Market has more emotional than logical investors.
The most common reason that triggers buying or selling of stocks is news related to company.
Investors must decipher between good and bad news.
Good news triggers stock buying. Bad news triggers stock selling.
The problem is that there is no set rules to differentiate good news from bad news.
The information coming out in market about company/economy is complex.
In this world there are as many stocks as there are investors.
Individual investors has their own set of philosophies of buying and selling of stocks.
- Like Warren Buffett believes in value investing.
- Peter lynch believes in growth investing.
- Harshad Mehta, a day trader, treated stock market like casino.
Value investing, growth investing and stocks trading practices explains why do stock prices change so much.
Cause #1. Financial Statements
There is no news more reliable about company than its financial statements.
Listed companies are obliged to announce/publish their financial performance every quarter/year.
The information appearing in financial statements can trigger buying and selling of stocks.
Why do stock price change so much when company reports higher profits?
One financial parameter that influences stock prices most is earning per share (EPS).
Higher profit generally means higher EPS.
Market price of stocks follow the proportionate growth in EPS grows.
Similarly when EPS of stocks falls, market price of stock will also fall.
Cause #2. Earnings/ Profits…
The logic is simple.
A company which is making higher profits will be preferred by investors.
Higher earnings (EPS) will cause the stock demand to go up resulting is higher prices.
Ideally, companies stock price shall be driven by three things:
- Profitability &
- Debt Levels.
Profit of company is best represented by EPS.
Investors shall look at last 10 years EPS of company.
If EPS growth is continuous and robust the stock becomes eligible for buying.
More buying of stocks will result in market price appreciation of stock.
If a company which is continuously increasing its EPS years after year is a good buy.
Generally company tends to maintain its P/E ratio.
When E (EPS) increase, P (Market Price) will also grow.
But it is point worth mentioning that, EPS of company is reported once every quarter.
But price fluctuations haves every few seconds.
So for sure EPS changes does not justify every day volatility of stock price.
Every day volatility of stock price is influenced by daily demand for stocks.
Cause #3. Financial Institution
When financial institutions buy or sell stock they do it in huge quantity.
Financial institutions like Mutual Funds, Life Insurance Corporation etc are big players on stock market.
When they buy a stock, its price touches sky.
When they sell stocks its price tumbles like falling cards.
Indian stock market is also influenced heavily by Foreign Institutional Investment.
Foreign investment lifts or drags the market by huge number.
Every day some big players leaves mark on the market.
Mutual funds activity are very crucial for volatility of stock market.
Every day they buy sell stocks.
The day mutual funds are booking profits, stock price will fall.
Activity of mutual fund companies etc are called as speculative factors.
Speculative factors are more dominant that value or growth investing.
Cause #4. Change in Political / Economic conditions
Suppose there is a crisis is Europe and Institutions from this region decide to book profits.
When people/institutions decide to sell fearing tough times ahead it causes price falls.
In this case there will be heavy selling resulting is stock prices to fall.
Even though the fundamentals of stocks are strong the prices will fall.
One shall not bother too much about fluctuating market price of stocks.
Volatility is an inherent quality and it will never leave stock market.
So let’s accept this fact that stock prices are highly volatile.
The speculative forces will continue to dominate and price will remain volatile.
Instead of worrying we shall think how to take advantage of price volatility.
At times due to price volatility, fundamentally strong stocks becomes undervalued.
This is the moment when one shall buy quality stocks.