Which Factors Impact Stock Prices?
Nearly any daily occurrences can affect stock prices. The market is simply a reflection of how much different industries and companies are valued within our society. As human beings are fickle and our values change over time, this will be reflected in the market.
Breaking company news or a PR crisis will inevitably affect stock prices. When investors start to feel some concern, this will be reflected in stock prices falling. Other factors can include the interest rates imposed by the Federal Reserve, global events, such as wars, and emerging technologies that change the face of an industry.
The most significant factor that influences stock prices, however, is the profit that a company generates. Many people use stock analysis tools to help them gauge when stocks are going to rise and fall.
Fundamental Factors
Profitability and the valuation ratio can be considered the two most fundamental factors when it comes to stock prices. Total profit is the result of many factors. This includes a company’s cost management, competency, and revenue potential.
The valuation ratio may seem a little more abstract. It indicates the relationship between a financial metric (this could be revenue, earnings, cash flow, etc.) and the market value of the company.
The most well-known metric is price-to-earnings or P/E. This is the ratio of a company’s share price to its earnings per share. These ratios can be used to compare similar companies. They can give you a history of the company and help you to project their financial future.
Technical Factors
These are the factors that will change the supply and demand of a stock. They won’t fundamentally change the prospects of the company generating cash.
For example, let’s say a company was trading at $200 per share, and their enterprise was worth $200 million. If they offered a 2-1 stock split, the shares would trade at $100. However, the value of the enterprise would not change, as there would be twice as many shares available.
Some investors may be lured in by the lower price, even though nothing fundamentally changed at the company. Technical factors may also include the time of day or the day of the week that a trade happens. Price movements of stocks in the same industry can affect stock prices.
These technical factors help us to understand some of the supply and demand dynamics in the stock market. Company and industry trends are also considered to be a technical factor.
News
When thinking about breaking news, it’s important to consider what news is going to change the fundamental factors versus news that will simply alter the short-term supply and demand of a stock. The latter can just be considered noise that you don’t need to pay too much attention to.
Any news that is going to seriously affect a company’s ability to earn profits in the future is going to have a huge impact on stock prices. The release of quarterly earnings reports may cause a stock to rise or fall in price.
News events that affect the world at large can also change stock prices. During the COVID-19 pandemic, the stock market took some major hits. This continued as recently as last summer, as the Delta variant caused market traders to worry about market recovery.
Market Sentiment
Market sentiment means how investors look at a stock’s performance in the market. This sentiment is what drives demand for a stock. This then influences the supply. Anything that affects supply and demand is critical when it comes to stock price fluctuations. Investor psychology is absolutely critical when it comes to changes in the market.
The Behavioral Financial Theory looks at psychological factors whilst analyzing financial markets. It tells us that investors will act on emotion. Overconfidence in a particular asset can cause poor investment decisions.
The Animal Spirit Theory tells us that people act on instinct when they are uncertain. This means that moves in the stock market will also be based on instinct. When the market is good, many investors will buy. When the market is bad, many investors will sell. This may not be the best strategy, but it will drive many people.
Market sentiment can be measured by using a fear and greed index. A high degree of fear means people have no trust in the market and will look to sell. A high level of greed indicates that prices are going up and people want to buy in.
How Can I Protect Myself?
It’s inevitable that we will all use some level of instinct and intuition whilst investing. Even with the best research, there will still be a level of emotion involved. Remember that investing always comes with some risk. It’s a good idea to diversify your portfolio so that this risk is spread out over several assets.
ETFs and index funds can be a great way to build wealth with a low level of maintenance. They also have a low barrier to entry. If you want to invest in individual stocks, make sure you do as much research as possible. Make sure you understand the stock’s history and potential future.
Remember that the stock market is always going to have its ups and downs. Invest smartly, devising a strategy that suits your financial goals. Keep your focus on the long-term. Making hasty decisions based on the short-term is likely to lead to bad decisions based on panic or fear of missing out.
In Summary
Stock prices will be affected by fundamental factors that show the core financial metrics of a company and how much profit they generate. Technical factors can affect supply and demand but will not change these core financial metrics.
Breaking news can affect stock prices. This may be noise you can ignore, or it may be more serious. Market sentiment is an essential component in stock prices and tells us how investor psychology is moving the market.
