What moves the price of stocks?

If you’re a long-term investor, paying attention to the minute details of how your portfolio is performing can be counterproductive. You’re more likely to make a rash decision and harm progress toward financial goals if you’re constantly fretting over how stocks are moving over the short term. 

Nevertheless, it’s still valuable to understand what forces influence the price of stocks. This way, you’ll know what to expect from your portfolio when market news breaks. This can eliminate surprises, offer peace of mind, and help you stay committed to your chosen long-term strategy. 

Of course, understanding how a stock might move also helps when it comes to picking investments, so let’s examine some of the things worth looking out for. 

Supply & demand 

Just like with products we buy every day, the price of stocks is largely affected by supply and demand. 

Public companies only issue a set number of shares. When more people buy these – i.e., when demand for the stock is high – their prices rise. When investors are looking to sell, their prices fall. 

A range of factors can determine the supply and demand for a stock. These, in turn, can influence the prices of shares. 

Valuations 

Stock valuations tell you whether stocks are overpriced or under-priced relative to what’s happened in the past. 

Let’s say that in the run-up to Christmas, you're looking to pick up a new pair of runners for yourself. In December, they're full RRP at $200 — way more than they're worth in your opinion. However, you're pretty confident that if you can just hold off until January (after everyone's given up their New Year's resolution of joining a run club), you'll be able to get them for a steal at $80. This isn’t dissimilar to how many investors look at stocks. 

If you identify that a stock you own is overvalued, you could take it as a signal to sell off your positions. When you find an undervalued stock in your portfolio, you may want to accumulate some more shares. 

Professional investors assess whether a stock is undervalued or overvalued by analysing what are known as its fundamentals.

These are sets of metrics that reveal more about a company’s financial situation. 

A popular such valuation metric is the price-to-earnings – or P/E – ratio. As the name suggests, the ratio is calculated by taking a stock’s price and dividing it by its annual earnings. 

 "P/E valuations are useful and can provide some perspective on how elevated or undervalued stock prices are." 

Investors often expect a company to have a certain P/E ratio depending on what industry it’s in. If a firm’s P/E ratio is below this value, it may be undervalued, meaning there might be a buying opportunity. If it’s above it, it could be overvalued, meaning selling could become a consideration. 

This valuation method, however, has become more complex since 2008 with very low interest rates persisting until 2022. P/E ratios have generally remained elevated since the Global Financial crisis – which in the past may have indicated stocks were overvalued. Yet, this period also saw plenty of very good times to be invested, including most of the time from 2010 to 2021. Past performance is, of course, no indication of future results. 

That said, P/E valuations are still useful and can provide some perspective on how elevated or undervalued stock prices are. 

Monetary policy 

Monetary policy refers to how governments and central banks manage the economy through money supply and interest rates. 

From 2008 – in response to the global financial crisis – many central banks worldwide adopted quantitative easing, essentially injecting cash into the financial system and pushing interest rates lower. 

Low interest rates and increased money in the financial system are generally positive for stocks. Lower interest rates make it cheaper for companies to borrow and grow, while the reduced returns on savings make stocks more attractive to investors, often driving up stock prices. 

There’s obviously a flip side to this. If the money supply shrinks and/or interest rates increase, these generally have a negative effect on stock prices. Central banks may raise rates if they fear the price of goods – i.e., inflation – is getting out of control and needs to be stabilised. Higher rates incentivise people to save more and spend less. 

As rates rise, the cost of borrowing for companies also goes up. If they already have debt, it becomes more expensive to pay it back. Higher interest rates will also be used in calculations of predicted earnings, which will turn out lower as a result. 

Market sentiment 

If you’re bullish as an investor, you act believing prices will rise. If you’re a bearish investor, you think they’ll fall. 

Market sentiment refers to how bullish and bearish investors are as a group. Anything extreme can signal it’s time to expect movement in your portfolio. It may also represent a good buying or selling opportunity. 

"Market sentiment refers to how bullish and bearish investors are as a group about the stock market. Anything extreme can signal a good time to buy or sell." 

If sentiment is overly high – relative to what has happened in the past – this could indicate the stock market is ready to decline. If it’s overly low, it might be due to rise. 

Think about people around a swimming pool on a hot day. It makes sense that several people think having a cool dip is a good idea. As a result, the pool is crowded as everyone splashes about. 

Over time, however, people will have cooled off sufficiently – or decided sharing the water with a bunch of strangers isn’t all it’s cracked up to be – and return to their deck chairs. Gradually, the pool will empty out until no one is swimming. 

That’s kind of how market sentiment works. If most agree on the direction of the market, buying and selling stocks accordingly, then who is left to keep pushing it in that direction? Very few people. The price direction will generally reverse. 

A popular tool is the CNN Fear & Greed Index, which measures a total of seven sentiment indicators. A reading over 80 – and especially 90 – signals the market is getting euphoric and may be due for a correction. Readings below 20 – and especially below 15 – are generally bullish. 

External economic factors 

There are several factors outside a company’s direct control that may impact its share price. 

Some of these are obvious – the overall economic environment, for example, or the current rate of inflation. Others are less so, like currency trends or even the demographics of investors buying stock. 

The presence of these factors may turn market sentiment bullish or bearish. They may also impact company fundamentals, which in turn may determine how a stock’s price moves. 

News

Significant news events often move stocks, particularly if the headlines involve positive or negative events for a public company. 

The most obvious example of this is when companies release earnings. If firms report fundamentals that beat analysts’ expectations, then their stock often rises. If it’s the opposite and they fail to meet what’s expected, then stocks can fall. 

One caveat is that a company's earnings report might include information that worries investors, causing the stock to drop, even if the earnings are good. 

Let’s say for example, that Company A beat analysts’ expectations when it came to earnings. Those earnings, however, were largely attributable to an arm of the business that is due to be shuttered in the next 12 months. Investors may be fearful that the profits aren’t repeatable and sell the stock, resulting in its price falling. It’s worth checking, therefore, the underlying reasons why companies have beaten or fallen short of expectations.

Liquidity 

Market liquidity refers to how easily you can buy or sell an asset, like a stock, without affecting its price much. When investing in big companies like Apple, it's easy to buy or sell shares because many people trade them every day, so one person's actions usually do not impact the price much. It’s a bit like how, when you jump into an Olympic swimming pool, the overall water level hardly moves. In contrast, smaller companies are less liquid since there are fewer buyers and sellers, which means prices can change more when someone trades. 

Using this information 

In conclusion, if you notice a sudden change in your portfolio, the first step is to understand what caused it. The price shift might have occurred due to one of the factors mentioned earlier. For example, has the company recently released its earnings report, or has a prominent figure called it "overvalued"? By understanding these factors, you can remove some of the mystery from investing and stay focused on your financial goals and long-term strategy.