When a company does well in the marketplace, financial indicators such as revenue and earnings rise. When companies publicize these healthy fundamentals, theirВstock price is likely to rise as well. In the long run, no matter what happens to prices from day to day, a healthy, growing company\’s stock price should increase. Investors themselves can make stock prices rise through optimism. If the market becomes upbeat about a companyвs future, demand for the stock will jump as investors value it more highly, causing the price to rise. This effect of market valuation makes stock prices fluctuate daily and weekly.
Because the stock market is an auction made up of buyers and sellers (including individuals, corporations, mutual funds, and more) of shares of publicly traded companies, fluctuations in stock prices is nothing out of the ordinary. In fact, the price of companys stock can vary drastically from one day to the next. Before adding shares of stock to your portfolio, it is important to understand what causes stock market fluctuations and its risks. Giordano Trabucchi / EyeEm / Getty Images Ask anyone about the stock market and it s clear that almostPeveryone can agree on one thing: the prices of stock fluctuatePfrequently, increasing and decreasing in market quotation sometimes by shocking amounts in a single trading day.
PWhy do stock prices fluctuate? PWho or what is causing them? PThose are great questions and most often asked by novice investors. PTo help you understand, I m going to give you a basic overview of some of the forces that cause this volatility. PSome of this will be a bit of an oversimplification but by the time you re done reading it, you ll know a lot more than the general public about the way the stock market works and how stock prices are set. First, realize that the secondary stock market (as opposed to the primary stock market in which companies issue in exchange for cash) is an auction. PThat means there are buyers and sellers lining up on either side of a potential trade, one party wanting to sell its ownership, one party wanting to buy ownership. PWhen the two agree upon a price, the trade is matched and that becomes the new market quotation. PThese buyers and sellers can be individuals, corporations, institutions, governments, orP Pthat are managing money for private clients,P,P,Por pension plans.
PIn many cases, you won t have any idea who is on the other side of the trade. Because the stock market functions like an auction, when there are more buyers than there are sellers, the price has to adapt or no trades are made. PThis tends to drive the price upwards, increasing the market quotation at which investors can sell their shares, enticing investors who had previously not been interested in selling to sell. POn the other hand, when sellers outnumber buyers, there is a rush to dump stock and whoever is willing to take the lowest bid sets the price resulting in a race-to-the-bottom. PThis can be a problem, particularly during periods like the collapse of 2007-2009 because firms such as Lehman Brothers were forced to dump anything and everything they could to try and raise cash, flooding the market with securities that were worth far more to a long-term buyer than the price at which Lehman was willing to sell. There are a myriad of factors that can cause the relationship between buyers and sellers to change.
PInP, I broke out four such examples after. We talked about. We talked about the commodity nature of stocks. We talked about. We talked about. PI built upon this in an article calledP Acquiring Undervalued Stock for Your Portfolio by Buying on Bad News. In some cases, stock prices fluctuate because a requisite percentage of money flows in the market at any given time aren t taking a. PAn illustration I used was the equity valuation assigned to renowned jeweler Tiffany Company. PThe volatility of Tiffany s share price years ago when I originally wrote this article was entirely unwarranted by the long-term value of the firm. PFirst, pushed the price far beyond what any conservative buyer would want to pay and when it looked like the world might struggle for a bit, dumped it, driving it down below what the same conservative investors might want to pay. PThis volatility can cause the journey to be rough but that is the reason it is important to have a diversified portfolio and focus on the. To learn more about this topic, readP.