The stock market is a complex, interrelated system composed of large and small investors making uncoordinated decisions about a huge variety of investments. The market could be construed as an ecosystem organized by an invisible hand. Each market participant acts and plays freely based on their individual ideas and following their own personal interests. "The market" is shorthand for the collective values of individuals and companies.
There are basic economic principles that can help explain up and down market movements, and with experience and data, there are more specific indicators that market experts have identified as being significant.
Key Takeaways
"The market" is not a monolithic entity but a complex system of individual, professional, and institutional investors, each making decisions based on their own views and interests.
The law of supply and demand holds true as in any market.
Some factors, such as the rate of inflation, have the power to move the market as a whole higher or lower.
Other factors, such as corporate earnings, may move a single company or an industry sector.
In a market economy, any price movement can be explained by a temporary difference between what providers are supplying and what consumers are demanding.
This is why economists say that markets tend towards equilibrium, in which supply equals demand. This is how it works with stocks, too. Supply is the number of shares people want to sell, and demand is the number of shares people want to purchase.
If there isa greater number of buyers than sellers (more demand), the buyers bid up the prices of the stocks to entice sellers to sell more. If there are more sellers than buyers, prices go down until they reach a level that entices buyers.
Individually, security instruments like stocks and bonds are dependent on the performance of the issuing entity (business or government) and the likelihood that the entity will be valued more highly in the future (stocks) or be able to repay its debts (bonds).
Widely Accepted Market Indicators
This begs another question: What creates more buyers or more sellers?
Confidence in the stability of future investments plays a significant role in whether markets go up or down. Investors are more likely to purchase stocks if they are convinced their shares will increase in value in the future. If, however, there is a reason to believe that shares will perform poorly, there will be more investors looking to sell than to buy.
Events that affect investor confidence include:
The publication of economic indicators such as the Consumer Confidence Index
Changes in the level of trust placed in an industry such as the financial sector
Changes in the level of trust placed on the legal system
The largest single-day decrease in the history of the Nasdaq Composite Index took place on March 16, 2020. The market "lost" (traded down) 970.28 points, over 12% of its value. This move is attributed to the COVID-19 pandemic, which created a lot of uncertainty about the future. Therefore, the market had many more sellers than buyers.
Interest rates also may play a role in the valuation of any stock or bond. There are several reasons for this, and there is some debate about which is most important. First, interest rates affect how much investors, banks, businesses, and governments are willing to borrow, therefore affecting how much money is spent in the economy. Secondly, rising interest rates make certain "safer" investments (notably U.S. Treasuries) a more attractive alternative to stocks.
Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circ*mstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future performance. Investing involves risk, including the possible loss of principal.
Stock prices change everyday by market forces. By this we mean that share prices change because of supply and demand. If more people want to buy a stock (demand) than sell it (supply), then the price moves up.
The law of supply and demand holds true as in any market. Some factors, such as the rate of inflation, have the power to move the market as a whole higher or lower. Other factors, such as corporate earnings, may move a single company or an industry sector.
The more people want something, the more demand there is. That means that they can be sold for more money. However, if there are lots of people selling (or supplying) the same goods, and there are not many people who want to buy those goods, then the demand will drop and the prices will be lower.
In summary, the key fundamental factors are as follows: The level of the earnings base (represented by measures such as EPS, cash flow per share, dividends per share) The expected growth in the earnings base. The discount rate, which is itself a function of inflation.
When does the stock market fluctuate? Like any other product, the price of shares hinges on supply and demand. Prices rise when the supply of shares for purchase is not enough to meet the demand of investors; they fall when fewer investors are interested in buying shares. Indices tell us how the stock market is faring.
External factors such as industry shifts, government regulations, or even severe weather that affects company operations can also influence price changes; investors and analysts weigh how those elements may influence a company's' performance in the future.
In addition to the Federal Reserve's questionable policies and misguided banking practices, three primary reasons for the collapse of the stock market were international economic woes, poor income distribution, and the psychology of public confidence.
The sudden drop in stock prices may be influenced by economic conditions, catastrophic event(s), or speculative elements that sweep across the market. Most flash crashes are usually short bursts of market downturns that can last for a single day or much longer to bring investors heavy losses.
A stock market collapse typically occurs when the economy is overheated, inflation is rising, market speculation is rampant, and there is significant uncertainty about the path of an economy.
Sharp increases in asset prices and a speedy expansion of credit often coincide with rapid accumulation of debt. As corporations and households get overextended and face difficulties in meeting their debt obligations, they reduce investment and consumption, which in turn leads to a decrease in economic activity.
As the demand for a particular good or service increases, the available supply decreases. When fewer items are available, consumers are willing to pay more to obtain the item—as outlined in the economic principle of supply and demand. The result is higher prices due to demand-pull inflation.
So if the monetary policies are looking to expand economic activities by promoting investment, then the economy booms. On the other hand, if there is an increase in taxes or interest rates we will see a slowdown or a recession in the economy.
As we can see on the demand graph, there is an inverse relationship between price and quantity demanded. Economists call this the Law of Demand. If the price goes up, the quantity demanded goes down (but demand itself stays the same). If the price decreases, quantity demanded increases.
When the economy is contracting, deflation will tend to occur, and as a result, falling prices will be present. In contrast, when the economy is expanding, inflation will tend to occur, and as a result, rising prices will be present.
High demand is the primary driver of what makes a stock price go up. The higher the demand, the higher the price investors will be willing to pay for each share (and the higher the price owners will be demanding to sell their shares). Similarly, low demand is the primary driver of what makes a stock price go down.
What goes up if the stock market crashes? There is nothing that will definitely go up if the stock market crashes. Interest bearing investments such as money market funds will continue to earn interest. Bonds may hold their value or increase, and individual bonds including Treasury's will continue to earn interest.
You can identify an up-trend by spotting a series of bars with higher highs and higher lows. Similarly, a down-trend can be identified by a series of bars with lower highs and lower lows.
A stock market fall can occur as a result of a large disastrous event, an economic crisis, or the bursting of a long-term speculative bubble. Reactionary public fear in response to a stock market fall can also be a key cause, prompting panic selling that further depresses prices.
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