One day it might be booming; the next day, it could go bust. What actually causes stock prices to change?
If you’ve ever created a stock watchlist or even own a portfolio of your own, you’ll know that stock prices are constantly changing. Particularly volatile stocks (like penny stocks) can sometimes move as much as 50% over the course of a day, while larger companies like Coca-Cola might only move a few percentage points a year.
But what actually causes those change in prices?
Day-to-day, stock market prices change primarily due to market sentiment. When the market feels good about a company, more people will want to buy the stock and the price rises. When the market feels bad about a stock, more people want to sell the stock and the price falls.
When you put it like that, it all seems very obvious. However, the more complex thing to uncover is the factors that actually affect those changes in market sentiment:
1. Company News
The latest news about a company is often the biggest influence on a stock price’s movement in either direction.
Good news, like a patent being approved or the announcement of a great new product, can cause a company’s stock price to rise. Meanwhile, news that a popular CEO is resigning or that a product is being recalled will have an adverse effect on the stock price.
Although news and speculation can cause stock prices to change, it’s important to remember that a lot of what you hear should be taken with a pinch of salt. Financial commentators are always looking for the next big story to break, and some stories might simply be a case of a man biting a dog.
2. Economic News
On a broader scale, news about the economy, in general, can have different effects on different companies.
If we learn that consumer confidence is high, for example, luxury retailers will usually see a bump in their stock price. However, if unemployment levels increase, the very same companies could see their share price decline as consumers spend less money.
On the other hand, companies like Wal-Mart and Dollar Tree tend to do well in poor economic conditions. People will always need to buy groceries, but are more likely to go to a discount retailer in tougher times rather than somewhere more upmarket (and expensive) like Whole Foods Market. This is where we begin to see some of the real intricacies of market movements.
Changes in economic conditions can also affect the entire market. For example, if interest rates rise, investors may pull money out of stocks for more secure bonds or fixed-income investments. This could see stock prices fall across the board, regardless of what sector they belong to.
3. Earnings Reports
Every public company is required to release financial statements to the public every three months. Depending on how the company performs over the quarter, the stock price will likely react.
Wall Street analysts make estimates on how each company will perform and these act as benchmarks. If a company does better than these estimates, we call this “a beat” and the stock price will usually rise. If the company underperforms, however, we call this “a miss” and the stock price will tend to fall.
Some companies also issue guidance for how they will perform over the next year. If these are not in line with what Wall Street expects, the stock price will decrease.
4. Analysts Reports
Those same Wall Street analysts don’t just wait until earnings season though. They are constantly analyzing the markets and producing reports on public companies using a series of rating systems to in order to advise investors.
Some analysts rate companies with ‘Buy’, ‘Hold’ or ‘Sell’. Others use terms like ‘Underweight’ and ‘Overweight’ to describe their opinion on the price of a stock.
Whatever terms they use though, these ratings can often end up causing big shifts in a company’s stock price.
Though it’s less rare, sometimes a stock price can change because of how a competitor or partner performs. When this happens, investors usually call it “moving in sympathy”.
For example, if Under Armour reported a weak quarter, it is likely that Nike will also have a weak quarter since both companies sell similar products. Similarly, if Booking Holdings has a great quarter, it is likely that TripAdvisor will also do well. This is because a large amount of Booking’s business comes from their partnership with TripAdvisor.
As you can see, there is a multitude of factors that affect a company’s share price on a day-to-day basis. However, the important thing to remember is that all of these are short-term price movements.
Remember that the stock market can be an incredibly fickle place and that sentiments change rapidly.
Time and time again, it’s been proven that over the long-term, a stock’s price follows the company’s earnings. Great businesses are the ones that consistently reinvest their earnings back into the company and increase their earning potential over the course of many years—think Amazon, Google, or Apple.
Rather than worry about the daily movement of stock prices, you should invest in great companies and commit to holding them for the long-term.