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Stocks on the Rise and Fall: Understanding Stock Prices
For investors, one of the primary components of the investment making decision is deciding not just which companies to invest in, but when to invest in them. As the age-old saying goes, “Timing is everything.” And if timing is everything, then the successful investor knows how to take all of the information about a stock and determine if it is, indeed, the right time to add it to the portfolio. One of the most prime pieces of information that reveals a stock’s merit is its stock price.
Stock prices can change throughout the day, from when the market opens until it closes. Why do shares of a company rise and fall so much? Since the stock market functions a lot like a free market, the classic economic laws of supply and demand are at work. Demand is high for a stock when lots of people want to purchase it. Supply is high for a stock when lots of people want to sell their shares. When demand for a particular stock is high, and the supply for that stock is low, that is when the stock price rises. On the other hand, when a stock’s supply is great, but investors are not buying it (demand is low), that is when a stock’s price falls.
Now that sounds very simple, but the “market forces” are a little bit more complex. Because the market prices are determined by investor demand, companies do their best to showcase a promising future that will translate into future profits and dividend returns. Any news about companies - their practices and future products or services – can have an effect on investor demand, as well. The key information that grabs the attention of thriving investors is found in a company’s earnings reports. Accurate documentation of a company’s projected earnings is required to be prepared quarterly and this is often more useful to investors than daily rumors or sound bites. When reports are released, this can also affect the stock price. When the actual results meet the expectations, the price may not change; however, when a company does not perform according to their estimations, the price is likely to fall. Also, when businesses exceed expectations, prices will probably rise – the reason being the company’s shares have become more desirable.
Not only is this information useful in determining potential demand for a company’s stock, but it also gives investors a window into the company’s future potential value. It is important to realize that stock prices do not reflect what a company is actually worth. Instead, stock prices are a reflection of what investors think of their potential, and that perception may or may not be flawed or accurate.
In the end, nobody really knows for sure what the weather will be like tomorrow, or what stocks will rise and fall tomorrow. That does not mean that we cannot predict what will happen. Triumphant investors are like good meteorologists – they know how to read the signs that are placed before them and make the right calls. Understanding how and why stock prices fluctuate helps investors reach success.